Is There a Developing Trade War Between Indonesia, Malaysia and the EU?

14 August 2019 Jarryd de Haan, Research Analyst, Indo-Pacific Research Programme

Background

Indonesian President Joko “Jokowi” Widodo recently held a bilateral meeting with Prime Minister Mahathir in Putrajaya, Malaysia. At the meeting, on 9 August, the leaders discussed several issues, including the sanctions applied by the European Union (EU) on the importation of palm oil products. Speaking in Jakarta the following day, Indonesian Trade Minister Enggartiasto Lukita told reporters that the sanctions imposed on Indonesian and Malaysian palm oil were an act of ‘protectionism and trade war’ and he threatened to impose higher tariffs on EU dairy imports. Indonesian Foreign Minister Retno Marsudi also made comments along similar lines: ‘Let us cooperate, but if we face constant discrimination, then Indonesia and Malaysia will certainly not keep silent. We will fight’.

 

Comment

Palm oil is a significant commodity export for both Indonesia and Malaysia, with their combined exports to world markets totalling US$25 billion in 2018. The EU market makes up a significant portion of those exports, receiving 13.2% of the total in 2018. That market, however, is diminishing. In the past five years, palm oil exports to the EU have dropped significantly, from US$4.4 billion in 2014, to US$3.3 billion in 2018.

The reason behind that decline is a commitment by the EU to source its palm oil from sustainable sources. In April 2017, the EU adopted a resolution that called for a single certification scheme for palm oil entering the European market, as a part of wider efforts to curb deforestation and illegal logging.

Both Indonesia and Malaysia reacted strongly to the resolution, describing it as ‘unfair’. From Indonesia’s perspective, the resolution will make it difficult for its palm oil producers to enter the European market. Many of its plantations struggle to adhere to its own national standard (Indonesian Sustainable Palm Oil Foundation, or ISPO), which is less stringent than the main international certification standard (Roundtable on Sustainable Palm Oil, RSPO). That being said, together Malaysia and Indonesia export eighty per cent of the world’s palm oil, so it will be difficult for the EU to meet its demand for palm oil while excluding the two major exporters.

More recently, however, the European Commission concluded that palm oil biofuels are not eligible to count toward EU renewable transport targets due to excessive deforestation. That is significant, as almost two thirds of EU palm oil imports are used for biofuel, and its use for other purposes has been declining since 2013. That move is likely to see the EU market close its doors to much of Indonesia’s and Malaysia’s palm oil exports in coming years and look to other sources of biofuel. Simultaneously, it will make it easier for EU countries to meet palm oil demand from exclusively sustainable sources.

So far, efforts by both governments to present their respective palm oil industries as a sustainable option for the EU market have failed. Threatening retaliatory policies on EU imports, however, will achieve little. Both Indonesia and Malaysia are small players in EU international trade, whereas nearly ten percent of their exports are directed to the EU. That puts them in a disadvantageous position, as increased tariffs will impact the Indonesian and Malaysian economies significantly more than the European economies.

Retaliatory policies could also undermine Indonesia’s ongoing free trade negotiations with the EU. A better option would be to expand exports in other, less stringent, markets, such as China and India. Progress has already been made on that front, with an agreement in 2018 to increase Indonesia’s palm oil exports to China by up to 500,000 tons per year.

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