Asian Economic Review
2nd Quarter 1999
Indonesian Automotive Parts and Components Industry
Hiroshi Imai, Senior Economist
I. The Fragile Indonesian Automotive Parts and Components Industry
The Indonesian automotive parts and components industry is beset by a number of problems. This article discusses the current status of the industry and the problems it faces.
A. Problems Facing the Automotive Parts and Components Industry
1. Limited scale of operations
Due to the small size of the Indonesian market as a whole, individual brands and models are not produced in large quantity. This prevents manufacturers from reaping the benefits of mass production. It is very difficult under such circumstances to cut production costs, and production is inefficient. This situation is common throughout the Indonesian economy, and greatly impedes efforts to improve export competitiveness. The Indonesian automotive parts and components industry is certainly no exception to this pattern. The volume of OEM production is too small to generate economies of scale.
2. Excessive dependence upon the domestic market
In addition to the problem of excessive dependence upon the domestic market, many products are produced to meet specifications developed just for Indonesia. Assemblers have had to introduce models designed specifically for the domestic market.
In the case of automotive parts and components manufacturers, as well, all but a few were established strictly to supply assemblers operating in Indonesia, and their product line-ups are limited to parts used in models produced domestically.
3. Excessive reliance upon a single category of vehicles
Commercial vehicles accounted for 86% of the total number of motor vehicles manufactured in 1998. The Indonesian automotive industry thus shows a pronounced over-reliance upon Category I vehicles.
This heavy reliance upon commercial vehicles would not be a problem if manufacturers were only targeting the domestic market, but this lopsided production of a single type of vehicle is not in line with the needs of overseas markets, and is not good for an industry that intends to export its goods. Due to problems with quality and specifications, it is also difficult to export the parts for these vehicles.
4. Excessive reliance upon foreign manufacturers
The Indonesian automotive industry relies heavily upon foreign automotive manufacturers for the supply of production technology and key parts. This reliance upon foreign manufacturers is delaying efforts to localize automotive parts and components production, and it greatly increases the volume of imports. In addition, hardly any of Indonesia's automotive parts and components manufacturers have an R&D department, thus they depend upon parent companies or technical tie-ups for complete support in the development of export parts. They are also dependent upon outside help in the area of export marketing. It would be extremely difficult for these companies to develop overseas markets on their own.
5. Slow progress toward localization
As for the degree to which parts production has been localized, the Indonesian automotive parts and components industry achieved an average of 37.95 localization points for the Category I commercial vehicle in 1997. A higher degree of localization has been achieved in this category than in any other. At the same time, however, a survey by the Japan Auto Parts Industries Association (JAPIA) indicated that Japan-related automotive parts and components manufacturers operating in the ASEAN region had a local procurement ratio of 56.4% as of April 1997, meaning that Indonesia lags behind its neighbors in this regard. The fact that local procurement ratios in the ASEAN region lag behind those in the West and in other parts of Asia is a further indication of just how slowly Indonesia's localization effort is progressing.
6. Cost competitiveness and quality
Because parts and components production is not highly localized, parts and components must be imported and import duties must be paid. This naturally pushes costs upward. Even for parts and components that are produced domestically, cost has always been a secondary consideration because the government's automotive industry policy has slapped high tariffs upon imported parts and placed top priority on localization.
As for quality, requirements have tended to be rather lax by international standards because parts and finished products are generally sold only in Indonesia.
7. Difficulty of switching lines of business
Automotive parts and components manufacturers generally use production lines built specifically to turn out a particular product. In most cases, these production lines can only be used for automotive parts and components, and cannot be retooled to make other types of products, such as electrical equipment.
8. Impact of revisions to the automotive industry policy
The United States and the European Union (EU) lodged a complaint at the World Trade Organization (WTO) against Indonesia's localization policies, and in July 1998 a WTO panel issued a report calling upon Indonesia to formulate a new automotive industry policy. The key point of the report was its recommendation that Indonesia revise its policy of providing incentives for the localization of automotive parts and components production.
The Indonesian government is now in the process of revising its automotive industry policy. In the past, the government reduced the import tariffs paid by a particular company if it met certain local procurement requirements, but it will be impossible to continue this practice. After assemblers and parts makers lose these tariff reduction incentives, they will probably be less committed to localization. When it is to their benefit in terms of cost and quality to import parts, they are expected to do so with increasing frequency.
9. Impact of an expedited CEPT-AFTA schedule
The ASEAN Free Trade Area (AFTA) plans to implement the Common Effective Preferential Tariff (CEPT) system by the year 2002. Once implemented, import duties will be slashed to 0-5%. In addition, ASEAN member nations have agreed, under the terms of the ASEAN Industrial Cooperation scheme (AICO), to cut tariffs on an approved list of automotive parts and components even before the CEPT-AFTA tariff reductions are scheduled to go into effect. This lowering of import duties on automotive parts and components will make it easier for assemblers and parts makers to procure from anywhere within the ASEAN region, which could result in stagnation of domestic procurement within Indonesia.
B. Impact of the Asian Economic Crisis
Nearly 400,000 automobiles and more than 1.8 million motorcycles were produced in 1997, but these figures plummeted in 1998 to approximately 58,000 and 500,000. Production has decreased, both for assemblers and the parts makers who supply the assemblers.
The Indonesian Automotive Industries Association sees no signs of any serious recovery in demand for automobiles, and expects the market to remain weak for the next several years.
When the domestic market was undergoing rapid growth, the industry had its hands full just keeping pace with it, and had no extra resources to seek export growth. Now that the domestic market has gone into contraction, however, a number of problems have arisen that stand in the way of export efforts.
In addition to shrinking the domestic market, the Asian economic crisis has also highlighted how difficult it is for the automotive parts and components industry to shift to exports. The severity of the automotive industry's problems has increased, and the industry has grown increasingly fragile.
II. Why Is the Automotive Parts and Components Industry so Fragile?
A. Policy Problems
The automotive industry policy adopted in 1993 featured two main provisions: high tariffs on completely assembled automobiles, and a Localization Incentive System.
First, the high tariffs on completely assembled automobiles made imports prohibitively expensive. Automakers had no choice but to build assembly plants in Indonesia and start assembly operations there to ensure their continued ability to sell to the domestic market.
Second, a localization point system was introduced. Unfortunately, this system was not designed with a view to fostering the development of a parts and components industry. Furthermore, the Localization Incentive System required assemblers to take full responsibility for the localization of parts and components production. Auto assemblers, however, can only localize the production of parts and components when it makes good business sense to do so. This poorly conceived policy is one reason the automotive parts and components industry in Indonesia remains underdeveloped today.
Critics also point, however, to another policy-related reason for the lagging development of Indonesia's automotive parts and components industry-the Localization Incentive System makes it too easy for companies to win preferential tariff rates.
First, companies can earn quite a large number of localization points just through assembly operations. Second, companies can earn localization points even when they are heavily dependent upon imports at the sub-parts level.
In addition, an assembler of commercial vehicles need only earn 40 localization points to receive preferential tariff rates, while an assembler of passenger vehicles needs 60 points. Indonesia has been concentrating primarily on parts localization for commercial vehicles, and at the same time makes it much easier to receive preferential tariff rates in this category.
These lax requirements help assemblers limit their localization of parts to a very minimal level.
B. Unsatisfactory Localization Efforts by Manufacturers
Countries in the ASEAN region have long used high tariffs to impose de facto restrictions upon the import of completely assembled automobiles. As a result, manufacturers have had no choice but to limit their marketing efforts to the domestic market in the country where their assembly operations are located. These markets are small, however, and production volumes have been correspondingly low. Under such circumstances, it has been impossible to cut costs or generate economies of scale.
It is true that assemblers, in an effort to localize parts production, have established in-house manufacturing, induced parts suppliers from abroad to set up local operations, and taken steps to foster the development of domestic parts manufacturers. Nevertheless, it has not made good business sense to take these localization efforts beyond the absolute minimum. In other words, assemblers have worked to win maximum incentives from a minimum level of parts localization.
At the same time, parts and components manufacturers have also had good reason to hesitate about entering the Indonesian market. For all except the very largest parts and components makers, the establishment of overseas operations imposes a serious strain upon company resources. Even when they decide to set up such operations, they are only able to establish a single location in the ASEAN region, for example, or perhaps in all of Asia. The fact that these operations have only been able to supply a single domestic market has limited the scale of production and greatly discouraged investment.
Almost no progress has been made toward the development of domestic parts manufacturers. The production technology of local parts makers is at an extremely low level of sophistication. In addition, there is another even more insurmountable hurdle-the near total lack of supporting industries required for domestic parts production. Such industries include metal processing, machining, surface treatment, heat treatment, mold and die production, etc.
Finally, the existing parts and components industry is saddled with many problems. In addition to a very low level of accumulation, the fact that automotive parts and components manufacturers only turn out products targeted to the domestic market seriously hinders their ability to export, because it leads to quality problems and greatly reduces cost competitiveness.
III. Survival Strategy for the Automotive Parts and Components Industry
The domestic automotive parts and components industry will be exposed in the coming years to fierce international competition. Factors ushering in this competition include the elimination of the existing Localization Incentive System, and plans to reduce import tariffs on automotive parts and components within the ASEAN and APEC regions.
The first round of tariff reductions will come in 2002 when the CEPT plan is implemented. Once tariffs have been reduced, the cost gap between locally made parts and imports will disappear. In cases where costs for Indonesian products are high, domestic products will lose out in competition with imported alternatives. Domestic makers will also come under increased pressure in the area of quality. A relatively low level of quality has always been good enough for the domestic market, but in the future, competition within the region will be dominated by makers who offer the highest quality. Makers that are weak in the area of cost and quality will find it very difficult to survive.
Unless Indonesian parts makers produce parts domestically that are cost competitive vis-a-vis the international competition, they will be pummeled in the marketplace by less expensive imports. With respect to quality, as well, further improvement is needed.
In addition, manufacturers that now maintain operations in more than one country within the region will no longer need to do so once tariffs have been reduced, and they will concentrate on exporting from wherever their most efficient operations are located. Moves to consolidate operations are going to accelerate, and some operations in Indonesia are likely to be scaled back or closed down entirely.
The short-term problem for the Indonesian automotive parts and components industry is how to survive in the face of the current contraction of the domestic market. Over the medium to long term, the problem is how to survive in the face of international competition that is expected to grow increasingly intense in the coming years.
To resolve these problems, there are two main questions that must be answered:
What sort of long-term vision must the Indonesian automotive parts and components industry develop to ensure its survival?
What are the concrete measures it must take to achieve its long-term objective?
The most urgent problems, however, must be dealt with in the short to medium term. Over the short term, something must be done to deal with slumping domestic demand. Over the medium term, steps must be taken to respond to the expected intensification of competition with other countries within the region.
It appears highly unlikely, however, that the Indonesian automotive parts and components industry will be able to achieve significantly improved international competitiveness by the year 2002, when the first wave of intensified international competition is scheduled to hit. If the industry is forced to sally forth in this unprepared state against regional competition, the regional market may not be the only one where it loses out; imports could very well threaten it in the domestic market as well. It is imperative to stall for time, and observers do not expect the Indonesian government to accept the current CEPT schedule.