FLEGT licences fine, but success in the market depends on quality, shipment and price

Earlier this month, ITTO reported that Indonesia is due to issue the first FLEGT licences in November and observed that the Indonesian government and industry are looking to these licences to deliver significant market advantages (ITTO TTM Report 1–15 September 2016).

Handicraft production, Yogyakarta, Indonesia by EU FLEGT Facility

There are reasons for optimism, FLEGT licensing gives a green lane through the EUTR due diligence procedures, the economic advantages of developing a single unified system for all exporters, and the greater confidence such a system offers to both buyers and investors.

These are all benefits which will give Indonesian wood products a competitive edge in the EU market in the months ahead. However, prospects for Indonesian timber, and indeed any timber supplier into the EU market, are not only dependent on their ability to provide legality licences. 

The first question for international buyers, both in the EU and elsewhere, is not whether or not they have a FLEGT licence or other assurance of legality or sustainability, but rather are they able to offer products which are good quality, on time and at a reasonable price. 

Various indices of international competitiveness suggest that Indonesian exporters face significant challenges on these wider market issues. For example, in 2015, the World Bank ranked Indonesia at 109th on the “Ease of Doing Business” (EDB), significantly lower than Indonesia’s direct competitors in the timber sector such as Malaysia (18th), Thailand (49th), China (84th) and Vietnam (90th). 

The UNCTAD Line Shipping Connectivity Index shows that the logistics of shipping to world markets are significantly more challenging in Indonesia than in other South East Asian countries. In practice these indices imply that Indonesian products tend to be more expensive and to be subject to longer delivery times than competing products from elsewhere. 

At a High Level Market Dialogue held in Jakarta in November 2015, the Chairman of the Indonesian Furniture and Craft Association AMKRI commented that some furniture manufacturers are moving away from Indonesia to Vietnam because of ‘red tape’ and cost. Prices for equivalent furniture manufactured in Indonesia may be 15% to 20% higher than in Vietnam. 

The wider macro-economic background in Europe also presents challenges to Indonesian wood products. Indonesian exporters have to contend with the relative weakness of the euro, slow pace of recovery from the financial crises, the dominant position of domestic and Chinese manufacturers, and the strong fashion for temperate woods and wider market prejudices against tropical timbers. 

But it would be wrong to over emphasise the downside. Growth in the EU may be slow, but it is significant given the sheer size and wealth of the European economy. Despite barriers to Indonesia’s competitiveness in the EU, Indonesia is now the largest single supplier of tropical timber products into the EU by a significant margin. 

In the 12 months to end June 2016, the EU imported Euro1.01 billion of timber products from Indonesia, including Euro490 million of wood products (HS 44), Euro310 million of wood furniture (HS 94) and Euro213 million of paper (HS 48). This compares to Euro799 million from Vietnam (second largest supplier - nearly all furniture) and Euro533 million from Malaysia. Indonesia accounted for nearly a quarter of all EU timber product imports from tropical countries in the twelve month period.

Indonesia’s competitive position in various sectors 

In practice the competitive position of Indonesian timber products in the EU varies widely between sectors. In some sectors for niche tropical wood products, Indonesia is already the leading supplier and FLEGT licences will provide an opportunity to extend this lead. 

Indonesia is the largest external supplier of “continuously shaped” wood (HS code 4409) which includes both decking products and interior decorative products like moulded skirting and beading. EU imports of this commodity from Indonesia increased 3% from 88 000 cu.m in 2014 to 91000 cu.m in 2015 and Indonesia’s share of total imports (tropical and temperate) in both years was around 26%.

Indonesia is also the largest tropical supplier of wood flooring to the EU. Although still low by historical standards, EU imports from Indonesia increased 4% to 1.59 million sq.m in 2015. This is only a very small share of the overall EU market, which consumes over 100 million sq.m of wood flooring every year and which imported 29 million sq.m in 2015. 

However, the FLEGT licence should help rebuild the niche market for tropical wood floors, which still offer strong benefits - including a unique look and good durability – but have gone out of fashion in the EU in recent years. It’s notable that China, by far the EU’s largest single external supplier of wood floors, suffered a set-back in the EU market last year, with EU imports of Chinese wood flooring falling 7.4% to 17.5 million sq.m, the lowest level since 2005. Whether this might signal new opportunities for competing external suppliers like Indonesia, or is a sign of consumers turning more to domestic products, is hard to say at this stage. 

Plywood is a market sector where FLEGT licences might play an important role to boost demand for Indonesian product. EU imports of plywood from all sources increased sharply between 2013 and 2015, from 3.38 million cu.m to 3.92 million cu.m, a level not seen since before the financial crises. However, imports from Indonesia and other tropical countries have remained stubbornly low in recent years. After increasing 3% to 308,000 cu.m in 2014, EU imports of plywood from tropical countries fell back 6% to 291,000 cu. m in 2015. 

The share of tropical countries in EU plywood imports fell from 9.2% in 2013 to only 7.8% in 2015, the lowest level for at least the last 20 years, and probably much longer. Imports from Indonesia fell 5% from 117,000 m3 in 2014 to 112,000 m3 in 2015. However, Indonesia became the largest single tropical supplier of plywood to the EU last year as imports from Malaysia fell 11% from 121,000 m3 in 2014 to 107,000 m3 in 2015. 

In recent years, tropical hardwood faced plywood has lost share in the EU mainly to Chinese plywood faced with temperate hardwood (including poplar, eucalyptus and birch), and to Russian birch plywood. The plywood sector has been a strong focus for EUTR enforcement activities to date and, given difficulties of establishing traceability and relatively high illegality risk of some competing suppliers, Indonesia FLEGT licence should significantly boost competitiveness in this sector. 

Uphill struggle to increase share of EU furniture market 

Indonesia faces more of an uphill struggle to increase market share in the furniture sector. This is particularly critical given the sheer size of the market and the potential it offers to add value to the wood resource. However, it’s also a sector where the technical advantages of tropical wood are less relevant – at least in the interior furniture market which dominates sales – than wider competitiveness issues such as labour costs, red tape, logistics, processing efficiency, innovation, and marketing. 

Indonesia faces considerable competition in this sector, not least from the EU’s domestic furniture manufacturers which are hugely dominant, accounting for 84% of all furniture supplied within the EU in 2015. One clear sign of the rising global competitiveness of EU’s domestic manufacturers, boosted by the weak euro, is the region’s rising trade surplus in wood furniture. While EU countries imported wood furniture worth Euro5.78 billion from outside the EU in 2015, EU exports of wood furniture rose to Euro8.73 billion in 2015, up only 3.5% from 2014 but 51% more than in 2009. 

EU imports of Indonesian wood furniture increased by 7% to Euro316 million in 2015, which is encouraging but less dramatic than from other countries. EU imports of wood furniture from Vietnam increased 21.6% to Euro725 million in 2015. This follows 19% growth the previous year and is a clear demonstration of Vietnam’s rising competitiveness in global furniture manufacturing. 

Despite Vietnam’s rise, more than half of all EU wood furniture imports, Euro3.15 billion, came from China in 2015, with deliveries rising 12%. In 2015, EU imports also increased rapidly from Malaysia (+12% to Euro191 million), Turkey (+21% to Euro183 million) and India (+23% to Euro162 million). 

Mixed prospects for FLEGT licensed timber products 

In short, there are reasons to believe that FLEGT licensing will help improve competitiveness and could provide a fairly immediate boost to trade in those sectors where Indonesia has already established a strong market position and where EUTR regulatory activity has been focused – such as decking, plywood and wood flooring. 

However, significant gains in market share over the long term, particularly in high value sectors like furniture, will only be achieved if FLEGT licensing is combined with policies to improve the international competitiveness of Indonesian wood manufacturers across a wider range of issues. 

The good news is that the FLEGT process has some potential to enhance this process through the role it plays to increase industry co-operation, improve dialogue and information exchange with customers and suppliers, raise the overall image of Indonesian products and potentially encourage investment by reducing actual and perceived business risk. 

Indonesian supply of wood products to the EU must also be set within the context of the wider market opportunities available to Indonesian manufacturers. The influential “Global Construction 2030” report by Oxford Economics published in 2015 forecast that Indonesia will rise to become the world’s fourth largest construction market by 2030. 

The value of Indonesian construction is predicted to rise from around US$250 billion in 2015 to nearly US$700 billion in only 15 years, moving up from its current position as the 11th largest market to overtake Japan. The same report suggests that European construction will also grow, but only slowly from around US$1,800 billion in 2015 to US$2,250 billion in 2030, little more than the total value of the European market in 2007 before the crash (US$2200 billion). 

Therefore, the key challenge, and opportunity, for the SVLK system on which FLEGT licensing is based may ultimately lie in the role it plays to promote efficient delivery of legal and sustainable timber products into the domestic market and to promote new investment in forest, technical and human resources to supply that market.

Article originally published in ITTO's Tropical Timber Market Report,  Volume 20 Number 16, 16 –30 September 2016.