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Indonesia and the European Union (EU) took a major step recently to cement their economic relationship through the signing of a Partnership and Cooperation Agreement (PCA). The agreement, which was signed following a meeting between senior officials from both sides in Jogjakarta, on 13th and 14th July 2009, covers diverse areas of cooperation, such as trade, investment, human rights, climate change, and so on. The PCA with Indonesia is the first such agreement to be signed by the EU with Asian countries, thus, reinforces Indonesia's diplomatic standing in the eyes of European policy-makers. Despite this encouraging news, the signing of the PCA is likely to present considerable challenges, particularly for Indonesia. Amongst other things, the agreement paves the way for negotiations to resume on the long-awaited Indonesia-EU Free Trade Agreement (IEUFTA).Given the economic imbalance between the EU and Indonesia in the world economy, economic relations between the two sides remain in favour of the EU. Consequently, in order to redress this imbalance, the proposed IEUFTA must take into account the development objectives of Indonesia.

Key findings:

• Policy space matters for Jakarta because it allows the Indonesian government the sovereignty to determine the appropriate trade, investment and industrial policies that could help its own development amid the pursuit of economic liberalization.

• Jakarta and Brussels appear to have different interpretations on the way in which this trade agreement could contribute to the economic development of Indonesia. Brussels is convinced that extensive trade liberalisation is the route to Indonesian economic development, while, for Indonesia, the costs associated with the implementation of this trade agreement would be quite significant to bear.

• Indonesian manufacturers often complain about the current EU's policies concerning market access and subsidies. Whilst, on the surface, the EU has maintained generally low tariff rates on non-manufactured agricultural products, Indonesian exporters often hit by stringent non-tariff barriers which impede them from further penetrating the EU market.

• The IEUFTA must be examined critically because it is likely to uphold WTO-plus arrangement that may hurt the poor and marginalized sectors of the society.

Key recommendations:

Indonesia can certainly benefit from this trade agreement if the EU is willing to:

• Allow the use of SP / SSM measures under the IEUFTA;

• Expand its existing GSP scheme;

• Improve market access for Indonesian exports to the EU;

• Allow the use of subsidies for small-scale agricultural producers;

• Provide concrete commitments for long-term capital investment into Indonesia;

• Agree to the use of flexible timeframes for the conclusion and implementation of IEUFTA; and,

• Ensures the participation of civil society groups in the IEUFTA policy-making processes.