Last month, China and Indonesia signed an agreement to promote the use of local currencies — Chinese Yuan (RMB) and Indonesian Rupiah (Rp) — in trade and investment transactions between the two countries.
Yuan has actually penetrated Indonesia since China’s massive infrastructure project, the Belt and Road Initiatives (BRI), began in 2012. It is reported that currently, around 10% of Indonesia’s global trade uses Yuan. In 2018, the value of Yuan reached 201.2 billion RMB (US$29 billion) or about 63% of the entire Indonesian market.
The agreement marks a key milestone in strengthening bilateral financial cooperation between the world’s largest exporter, China, and Southeast Asia’s largest economy, Indonesia.
The agreement would also affect the political relationship between the two countries.
The recent agreement would reduce China and Indonesia’s dependence on the US Dollar as the world’s main currency in their international transactions.
For China, throwing away the US dollar means avoiding the prospect of being subject to US jurisdiction.
This could also help China secure one of its major goals: to dominate international trade as the world’s largest producer.
Meanwhile, Indonesia’s central bank hopes the agreement would help the country’s reduce its risk against fluctuation in the US dollar.
The US dollar accounts for about 90% of Indonesia’s foreign transactions.
The use of local currencies could help Indonesia maintain financial stability amid global financial market uncertainty caused by the pandemic and the US-China trade war.
The financial dispute between the US and China has weakened global economic growth because reduced trade activity has increased global uncertainty, especially for an emerging market such as Indonesia.
Responding to its dispute with China, the US’ Fed increased the very rates that make the US dollar attractive, forcing investors to pull money from the Indonesian market. That led to depreciation in the Rupiah. Rupiah experienced the biggest drop in 20 years, to Rp 14,777 against the US dollar.
During the COVID-19 pandemic, the Rupiah declined again to Rp 15,000 against the greenback.
Meanwhile, the Rupiah exchange rate against Yuan remains stable at between Rp 1,900 and Rp 2,100 against Yuan. Therefore, transactions using Yuan would be cheaper.
The agreement is also crucial for Indonesia because Indonesia’s international trade with China — and the flow of Chinese foreign investment to Indonesia from Asian countries in general — has increased significantly.
Before the pandemic, China was the largest trading partner for Indonesia’s non-oil and gas products.
In 2019, China was Indonesia’s biggest export destination country, with a value of US$ 25.8 million — around 16.68% of total exports. In the same year, China was the largest importer for Indonesia, worth US$44.5 million, equivalent to 29.95% of Indonesia’s total imports.
Also, Chinese investment in Indonesia has rocketed in the last five years.
In 2019, China was the second-largest investor with a total investment worth US$4.7 billion, equivalent to 17% of total investment. The increase in Chinese investment into Indonesia has begun to shift the dominance of Singapore as Indonesia’s top investor.
Despite having China as one of its main trade partners and top investor, Indonesia rarely uses Yuan in its transactions. The Indonesian Employers Association chairman Hariyadi Sukamdani said only 10% of Indonesia-China trade used the Yuan in 2018.
However, the Chinese government’s tendency to devalue its currency means Indonesia faces some risks if it turns to Yuan.
In recent years, China often devalues its currency to make it more responsive to market forces. In 2019, for example, Beijing devaluated the Yuan to make Chinese goods more competitive as the impacts of the trade war with the US began to bite.
If the Yuan is devalued, Chinese products will be cheaper and more competitive in the international market.
If Indonesia uses Yuan, Indonesian imports from China may soar, which would hit the domestic market.
Recently, Indonesian textile product entrepreneurs were furious to see rising textile imports entering the domestic market.
Indonesia and China’s currency agreement will also strengthen China’s growing foothold in Indonesia.
China is Indonesia’s second biggest source of foreign direct investment (after Singapore) and one of its major trading partners.
China is also reportedly hoping to establish a military base in Indonesia.
The agreement would mean make China not only has significant economic, cultural, and military influences in the country, but also a currency foothold in Southeast Asia’s largest economy.
Indonesia must set the rules of the game to ensure the widening use of Yuan benefits both parties — not just China.
At the same time, Indonesia needs to make sure China’s devaluation policy will not harm the former’s economy in the future. One strategy would be to diversify Indonesia’s imports from countries other than China. Another is to encourage investments in agricultural sectors that will reduce imports.
Indonesia could also diversify its partners by establishing local currency settlements with other countries.
To date, Indonesia has signed local currency settlements with Thailand, Malaysia and South Korea. To reduce its reliance on China, Jakarta could also establish local currency settlements with its non-traditional partners such as the EU and Gulf states.