THE DISPUTE OVER THE INDONESIAN NATIONAL CAR PROGRAM

| Case Study A |  Case Study B |

Simulations & Questions for Students Case A | Case B
 
| Teaching Note Available upon request from ICDP |

CASE A

Setting 

In 1995 auto industry exports only amounted to $250 million while imports were over $1.5 billion.  This situation cannot continue and it is imperative that we develop our own industry. 

 — Indonesian Minister for Coordination and Production, Harto May 1996[1] 

I made it clear that in our view, this [i.e., tax incentives and tariff exemptions] was a policy that was discriminatory against European car manufacturers and also that it was contrary to the obligations Indonesia has undertaken with the WTO…  

— European Union Commissioner for External Affairs, Sir Leon Brittan, following an April 23, 1996 meeting with Indonesia President Soeharto.[2]                

At the beginning of 1996, Indonesia was one of the most interesting places for global automakers to invest.  It appeared to offer many advantages to foreign investors—a population of 190 million people (the fourth most populous state in the world), extensive natural resources, a stable (if not democratic) government, decent economic growth (averaging 8 per cent in the 1994–1996 period) and an excellent repayment record on its huge but manageable foreign debt.  Investment in manufacturing and in consumer goods had great potential as the per capita GDP climbed above $1,000.  

By June of 1996, the situation had changed dramatically.  The introduction of Indonesia’s National Car Program in the spring of 1996 forced the leading motor vehicle manufacturers in Europe, Japan and the United States to revaluate their plans for the Indonesian market and to put their investments on hold.  Trade officials in the European Union, Japan and the United States, in a rare show of unanimity, threatened to take Indonesia to the WTO. 

Part I
The National Car Program  

On February 19, 1996 Indonesian Minister of Trade and Industry, Tungky Ariwibowo, launched a new National Car Program to foster development of an indigenous automotive industry.  The full program was spelled out in a Presidential Decree and several ministerial decrees, all enacted on February 19, but not announced until February 28.  

Presidential Instruction No. 2 of 1996 directed the Minister of Industry and Trade, the Minister of Finance, and the State Minister for Mobilization of Investment Funds to implement coordinated measures for the speedy realization of the national automobile industry.   

Ministry of Industry and Trade Decree No. 31/MPP/SK/2/1996, entitled “National Motor Vehicles,” implemented parts of Presidential Instruction No. 2 by providing that a  “national motor vehicle” must satisfy the following criteria: (a) be domestically produced using facilities owned by national industrial companies or Indonesian statutory bodies with total shares belonging to Indonesia citizens,  (b) use trade marks not yet registered in Indonesia and owned by Indonesians, and (c) be developed with technology, designs and engineering based on national capacity.  Automobiles companies that met the above requirements were to be called “pioneer companies”.  National automobile companies were to use an increasing amount of local content in their autos, starting at 20% at the end of the first year, 40% the second and 60% by the end of the third year. 

Ministry of Finance Decree No. 82/KLM.01/1996 revised Decree No. 645/KMk.01/1993.  The Decree in essence provided that parts and equipment used in the assembly or manufacture of a national motor vehicle may be imported duty-free rather than at reduced rates provided for in the 1993 incentives programs.  

Government Regulation No. 20/1996 of February 19, 1996, amended Government Regulation No. 50/1994 to exempt National Cars from the luxury tax.  The purpose of the regulation was to support further growth of the domestic automotive industry to make it globally competitive.[3] 

Kia Motor /Timor Putra Nasional Joint Venture — On Monday, February 26, 1996 Kia Motor Corporation (“Kia”) of Korea and the Indonesian company, PT Timor Putra Nasional (“TPN”) announced the establishment of a joint venture to produce national motor vehicles.  TPN happened to be controlled by Hutomo Mandala Putra, the youngest son of President Soeharto.  The joint venture, which was entitled PT Kia Timor Motor (‘Kia Timor”) and was 30% owned by Kia, announced that it would produce a car (to be called “Timor”).  The Timor was to be based on the 1,500cc Kia Sephia sedan and built at a plant to be constructed in Cikampek, West Java.  TPN said that it would produce 50,000 sedans by 1998 and intended to start selling cars in Indonesia by September of 1998.  TPN also said that its cars would sell at half the price of comparable models manufactured by Japanese subsidiaries in Indonesia.  In announcing the National Car Program, Tungky confirmed that the TPN venture would be the first and for the moment the only company to qualify for “National Car” status and for the tax and tariff benefits conferred by the program.  

The Government also announced a further series of measures on February 27 and March 6, 1996.  These measures (a) provided the investment approval and tax benefits needed for the establishment of a national car industry,[4] (b) designated TPN as a “pioneer national motor vehicle enterprise”[5] and (c) designated TPN to establish and produce a National Car.[6] 

Rational of Indonesian Government and Private Sectors Supporters — In launching the National Car Program Indonesian officials voiced unhappiness with the pace of development of a domestic car industry to date and expressed fear that they were falling behind other ASEAN countries.  Tungky said on Feb 28 that the National Car Program was designed to develop national self-reliance in the automobile industry, to allow the industry to export its products and to procure components from different sources.  Tungky also compared the program to the Proton program in Malaysia and stressed that “the Timor cars will be produced by PT Timor Putra as a wholly-owned Indonesian subsidiary.”[7] 

The PTN venture was not the first national car project envisaged for Indonesia.  In 1995 the National Science Agency had proposed to produce a national car and was still talking about it in 1996 and 1997.  President Soeharto’s support of his son was a key factor in determining the vigor with which Indonesia pursued the National Car Program.  

The National Car Program struck a responsive cord among some Indonesians.  Many Indonesians shared the view that Japan had held a virtual monopoly on the Indonesian car market since the 1960’s.  One business consultant said that if Japan had allowed Astra to export 8 years ago, Indonesia would not have been forced to turn to the Koreans.[8] On March 1 the Chairman of the Indonesian Chamber of Commerce and Industry Aburizal Bakrie welcomed the National Car Program with the following comment:  “I welcome and support any policy which will cut the prices of domestic products, including automobiles.”  Dr. F.H.H. Eman, former chairman of the Indonesian Motor Vehicle Association (Gaikindo) and current director involved in the TPN project, said that prior to the release of the new policy the automobile industry in Indonesia depended too heavily on companies in Japan and the United States and that now is the time to develop its own competitive, national automobile industry.[9]

On the other hand, the National Car program and the TPN venture were controversial from their inception in Indonesia.  The unexpected shift in policy contradicted the government’s recent May 1995 market-oriented policy of deregulation and liberalization of the automobile industry.  Local and foreign newspapers reported the stunned reaction of Indonesian manufacturers who were already involved in manufacturing foreign brand autos under license.  The stock of the leading local manufacturer of the Toyota, Isuzu and Daihatsu marques, Astra International, fell sharply after the announcement that Timor’s low price was expected to sharply reduce sales of other manufacturers.  By March 17 Astra’s shares had fallen some 28.3%.[10]  Indonesians stopped buying cars in anticipation of the cheaper Timors and even demanded a return of the down payments on cars they had already agreed to purchase.[11] 

Analysts noted that TPN would have a difficult time achieving its stated goals since it was a new company, had no manufacturing facilities in Indonesia, and would have difficulty satisfying the domestic content requirements of the national car program.  

One editorial noted that advantages to PT Timor Putra were immense as duties and taxes make up more than 60% of the showroom price of sedans.  The editorial suggested the government should really focus on investment for research, design, development and engineering if it wanted a competitive car industry.[12]  The National Car Program was most widely criticized because it favored one local firm over and above other Indonesian firms that had been in the auto business a longer time.   

The selection of TPN raised not only nepotism issues regarding whether a son of the President was being favored over foreign businesses and non-family business, but also the specter of a brewing family feud.  On March 15, President Soeharto’s eldest son Bambang Trihatmojo said that his Bimantara business would launch a 1,500cc sedan with the South Korean Hyundai Motor Corporation and that the sedan met the requirements for designation as a “National Car” and the tax and customs benefits conferred by the program.  Tungky repeatedly said that only TPN could benefit under the National Car Program during the next three years.  Many local observers, however, felt that Bambang had a reputation of getting what he wanted. 

On May 30 Bambang announced that he had received from the government licenses to manufacture 1500cc and 1600cc vehicles based on existing Hyundai models.  However, on May 31 Tunky again said that only PTN was to receive the tax and tariff benefits of the National Car Program and that they would not be extended to others.[13] 

Foreign Government and Auto Manufacturers Reaction, Japan — Japanese automakers responded to the National Car Program by shelving or threatening to cut back on production plans.  Both Honda and Mitsubishi said that they would scale back on projects to build an “Asia-concept car” in Indonesia.  Production of the Honda car was to start in August of 1996 and to carry an Indonesia brand name.[14]  Japanese manufacturers were concerned both that the Timor could grab a huge share of the Indonesian market (e.g., 75%) in the same way that the Proton had in Malaysia[15] and that the National Car Program would have an adverse impact on the investment climate in Indonesia.[16]  On the other hand, some Japanese parts suppliers hoped that the new policy would put pressure on the assemblers to reduce costs and increase domestic content and that their parts ventures in Indonesia would benefit from such a development.[17] 

The Japanese Government reacted soon after the announcement of the National Car Program.  The Minister of International Trade and Industry (MITI) said that Japan was examining various aspects of the issue, including the possibility of taking Indonesia to the World Trade Organization (WTO).  He hoped that Indonesia would consider withdrawing or revising the policy before the problem became more serious.[18]  Japanese government officials pointed out that they believed that the National Car Program violated the WTO TRIMs Agreement and provisions of the GATT.  Japanese officials were concerned that other countries would adopt national car programs if Indonesia’s plans were successful.  Brazil had already adopted a program in 1995 that hurt Japanese manufacturers.[19] 

Europe — The EU Commission also attacked the national car program.  During an April 23 visit to Jakarta, EU Trade Commissioner Sir Leon Brittan said that the policy discriminated against European car manufacturers and was contrary to Indonesia’s WTO obligations, including those under the TRIMs agreement.  Sir Leon said that the national car program hurt European manufacturers more that the Japanese because the Europeans primarily made sedans while the Japanese made a wider range of commercial and passenger vehicles.  He warned that the EU had different and separate interests from Japan and would not be satisfied even if the Japanese were accommodated.[20]

United States — US companies initially reacted to the National Car Program by announcing cutbacks in plans to invest in Indonesia while continuing to invest in other Asian countries.  Chrysler, which was seeking to develop joint automobile programs within the ASEAN region, announced that it had decided to postpone its plan to build a new factory in Indonesia because the climate was not considered to be conducive.[21]  In April, David Snyder, President of Ford’s Thailand Regional Office, said “Ford has a goal of 10 percent market share across Asia.  That’s a long-term regional goal.”  Snyder announced plans for new ventures in India, Thailand and Vietnam and expansion plans for Malaysia and South Korea, but said with respect to Indonesia that “If those [i.e., the national car] policies stay we’ll have to modify our plans in Indonesia.”  Ford had earlier announced plans to set up a complete knock down facility in Indonesia.[22]  

In May of 1996 the three big US automakers submitted a white paper outlining in detail their objections to the National Car Program.[23]  The paper warned that based on experience in other markets the National Car Program policies will result in less technology, fewer exports and lower employment than if the deregulatory policy established in 1993 were continued unchanged.  The US automakers also said that the 60% local content target was unachievable.  They noted that they had firm plans to assist the development of the auto industry in Indonesia and to make Indonesia a key part of their ASEAN, Asian and Global plans, but that these plans were on hold.  The industry contended that Malaysia’s efforts had failed since development of the industry in Malaysia was lagging behind that in other countries in Asia and the Proton was not completing successfully.

June 1996 Revisions to the National Car Program

By late May of 1996 TPN’s inability to meet its goal of selling Indonesia-made Timors in the local market by September 1 was self-evident.  In mid-May TPN President Hutomo said that the Astra group, the Indomobil group and PT Utadin would assemble the Timor.[24] However, by late May Kia admitted that TPN had approached these companies and was rebuffed.  Astra said it would have to build a new assembly plant, which would take nine months, and Indonmobil said it had no idle assembly facilities.  Kia announced that it would import 4,000 Timors in semi-knocked down (SKD) condition in June and TPN revealed that its assembly plant in Cikampek, West Java would only be ready in 1998.[25]  

As TPN’s problems grew proponents of the National Car Program increasingly pointed to the importance of the scheme for Indonesia.  Fritz Eman, President of TPN’s assembly division, said on May 28 that because foreign companies’ main concern was reaping maximum benefits from Indonesia’s huge market, not establishing a reliable domestic car industry, “it is very important for Indonesia to make a breakthrough in its car industry before the WTO’s free trade principles are fully applied in 2003”[26] 

After TPN encountered problems finding a factory in Indonesia in which to build the Timor, the Indonesia government announced in June of 1996 modifications to the program.  These modification provided that for a one-year period and on a one-time basis, National Cars in fully built-up form could be imported free of duty and luxury tax if they were made by Indonesian workers and satisfied the domestic content requirements of the National Car Program. 

In particular, on June 4, Presidential Decree No. 42/1996 provided that National Cars which are made overseas by Indonesia workers and which fulfill the local content stipulated by MIT will be treated equally with national cars made in Indonesia. 

Rather than require that Indonesian parts and components actually be used in the Kia Sedans imported from Korea, the government on June 4 introduced Ministry of Industry and Trade Decree No. 142/MPP/Kep/6/1996, which provided that the domestic content requirement on national cars produced overseas can be satisfied if the producer purchased a certain amount of Indonesian parts and components.  Under this counter purchase arrangement, the producer had to purchase a minimum of 25 percent of the import value of the national cars assembled abroad.  In sum, Kia only had to purchase Indonesian made motor vehicles parts and components in an amount equal to 25% percent of the value of the Kia Sephia sedans it was importing from Korea duty-free as the Indonesian “national motor vehicle.”

In announcing the new measures Tungky said on June 4 that the government would allow 45,000 Timor sedans to be produced in South Korea and imported into Indonesia and still receive the tax benefits of the National Car Program.  Tungky said this measure was necessary “to speed up the national car project”.  Tungky also said “The government gives PT Timor Putra Nasional a period of 12 months, from June 1996 through June 1997, to assemble the cars in Korea.  The deal will also involve the export from Indonesia of “a sufficient number of Indonesian workers who would be sent to Korea for an adequate amount of time” to produce the car and to “ensure an effective transfer of know-how”.  Kia sources indicated that about 1,000 Indonesian workers would be sent to Korea.

Also on June 4, Government Regulation No. 36/1996 modified the luxury tax schedule so that any sedans of less than 1600cc made in Indonesia with domestic content in excess of 60 percent would also be exempted from the luxury tax.  (National Cars were already exempt.)  This announcement was made in the context of a deregulation package, which provided tariff reductions on some 1,497 tariff line items.  Tungky’s announcement was less generous than it might at first appear.  None of vehicles manufactured in Indonesia could pass this 60 percent test.  Most sedans at the time had only 15 percent local content and the Timor was expected to have only 20 percent domestic content in the first year.[27]     

Foreign Reactions -- Foreign automakers and government officials from the EU Commission, US and Japan reacted sharply to the June 4th modifications in the National Car Program.  The Japanese automakers, who had the most to lose, and their government reacted first.  An outraged Japanese Ministry of Trade and Industry told the Nikkei Weekly that the Indonesia program was “sheer nonsense” and that Japan would take action in the WTO as soon as Indonesia imported duty-free cars from South Korea.[28]  Another MITI official said in early June, “going to WTO remained a strong possibility of Japanese action”.  However, Japan was not sending a clear signal regarding its intentions as the same MITI official conceded that at this point the possibility was a trial balloon.  Japanese officials also attempted to dispel speculation that Japan would use development assistance as leverage at an aid-pledging conference to be held in Paris on June 19.[29]  Japanese officials were worrying that Indonesia could respond to Japanese pressure by taking a tough stance on the supply of oil and gas.  One official spoke of patiently explaining to Indonesia that “this program is hurting Indonesia’s own interest” and companies would view Indonesia as a less favorable place to invest.[30] 

The Japanese auto industry was even more cautious.  An industry official noted that while the US and EU officials said that they would file their own complaint following a Japanese complaint to the WTO, he was not sure if such concerted action was possible.[31]  The Indonesians did not appear to be impressed and repeated that they were trying to develop domestic production.  Indonesian officials said privately that they did not take the WTO threat seriously since Japan was subject to complaints about its own protectionist practices.  Indonesian Foreign Minister Ali Alatas said:  “The matter will not disturb economic relations.  The Japanese government does not link this issue with others.”[32]

The US reaction was predictably strong from the beginning and along the lines of their reaction to the February program.  Andrew Card, President of the American Automobile Manufacturers Associations, said, “The National Car Program is a giant stop sign to investors.  The government changed the rules in the middle of the game.”  On June 11 Donald Sullivan, head of General Motors Asian and Pacific Operation, announced that the company had frozen its investment plans in Indonesia. 

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