37413
Public Disclosure Authorized
INDONESIA
Public Disclosure Authorized Essays on Agricultural Institutions and Policy
Public Disclosure Authorized
June 24, 1999
Public Disclosure Authorized Rural Development and Natural Resources East Asia and Pacific Region
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CURRENCY EQUIVALENTS (As of June 1, 1999)
Currency Unit = Rupiah 1 Rupia h = 0.00012 US$ US$1 = 7300 Rupiah
FISCAL YEAR: 1 January to December 31
ABBREVIATIONS AND ACRONYMS
ABN-AMRO - Dutch Bank ACDI/VOCA - BAPPENAS - National Planning and Development Body BGR - BKD - Village Credits Bank BKKBN - National Family Planning Board BRI - People’s Bank of Indonesia BULOG - Food Logistic Authority CIDA - Canadian International Development Agency CFTC - Commodities Future Trading Commissions EBRD - European Bank for Resonstruction and Development EKUIN - Economic, Finance and Industry GDP - Gross Domestic Product GOI - Government of Indonesia ICEB - IDF - International Development Fund IMF - International Monetary Fund KKPA - Credit for Members of Primary Cooperating KKOP - Credit for Food Crop Harvest and Distribution KLBI - Bank Indonesia Liquidity Credits KUD - Village Cooperative KUK - Small-scale Enterprise Credit Program KUPEDES - Village Enterprise Credit Program KUT - Farmer Production Credit LDKP - Lembaga Dana Kredit Pedesaan MOA - Ministry of Agriculture MMT - NGO - Nongovernmental Organization OPK - Rice Subsidy Program PHBK - PKM - Proyek Kredit Mikro RDKK - TPSP - Tempat Pelayanan Simpan Pinjam Undang-Undang Dasar - Law UPGM - USAID - United States Aid Development Program WRS - Warehouse Receipts System WTO - World Trade Organization
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PREFACE
The essays contained in this volume were produced by the Rural Development Unit of the East Asia and Pacific Region to provide background information for the continuing policy dialogue between the Government of Indonesia (GOI) and the World Bank. The topics selected are priority sectoral concerns for Indonesia as the government examines reforms needed to revitalize agriculture and the rural sector following the economic and political crisis of 1997-98. Information for the essays was collected by a mission that visited Indonesia in March, 1999. Preliminary findings were discussed with government officials at that time, papers were then completed, reviewed within the Bank, and commented on again by Indonesian officials and academics. The papers were then finalized and put together in this collection.
Authors of the papers are: Steven Tabor, consultant, Rice Price Policy and the Restructuring of BULOG; Donald Larson, the World Bank, Alternative Food Security Instruments; Stephen Mink, the World Bank, Rural Credit; Jock Anderson, the World Bank, Agricultural Cooperatives in Indonesia; Ian Gregory, the International Fertilizer Development Center, Fertilizer Policy; and Isabelle Tsakok and Ade Tunis, the World Bank and Ministry of Agriculture, Indonesia, respectively, Commercialization of the Seed Industry.
The papers were edited by Phil Sawicki and the work was under the general direction of Malcolm Bale.
The authors wish to thank the many officials of the GOI who provided information, detailed explanations, and valuable comments on the papers. In particular, Mmes. Delima Azahari and Ade Tunis, (EKUIN and MOA, respectively) and Mr. Gellwynn Jusuf (BAPPENAS), played a key role in identifying counterparts and in the review of the papers.
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TABLE OF CONTENTS
Page No.
I. RICE PRICE POLICY AND THE RESTRUCTURING OF BULOG...... 1 Policy Challenges and Constraints...... 2 Farm Income Support...... 3 Targeted Rice Distribution...... 4 Price Stabilization...... 5 Public Stocks...... 6 Rice Market Development Policy...... 6 BULOG Restructuring...... 7 Table 1: Rice Policy: Short and Medium-Term Reform Options 9 Table 2: Rice – Area Harvested, Production, and Yield, 1982-1998...... 12 Table 3: Food Price, Consumer Price, Exchange Rate and Rice Price in 1998 ...... 13
II. ALTERNATIVE FOOD SECURITY INSTRUMENTS: THE WAREHOUSE RECEIPTS SYSTEM...... 13 Exchange Delivery...... 13 Facilitating Trade ...... 13 Policy Instrument ...... 15 Prospects for Developing a Warehouse Receipts System in Indonesia ...... 14 Banks are Interested...... 14 Intermediaries...... 15 Warehouse Management Companies...... 15 Farmers’ Practices...... 15 Coffee and Cocoa...... 16 Other Major Crops ...... 16 The Rice Market in Indonesia ...... 16 Technical Issues ...... 17 Experience of Other Countries...... 17 Recommendations ...... 18
III. RURAL CREDIT ...... 19 Rural Credit Aggregates During the Crisis...... 19 Table 1: Commercial Bank Credits to Agriculture ...... 21 Subsidized Credit Schemes...... 22 Table 2: Bank Indonesia Rural Credit Programs ...... 22 Table 3: Subsidy Costs...... 23 Changes in the KUT Program...... 23 Commercial Programs of Rural Credit ...... 25 Table 4: Commercial Rural Credit Programs ...... 25 Table 5: Micro-Credit Programs...... 27
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Page No.
Policy Conclusions and Recommendations ...... 27 Table: Directions in Rural Credit Policy...... 31
Annex 1 – Commercial Banks’ Outstanding Rupiah Credits (Total, Investment, Working Capital) by Group of Bank, Total and Agricultural Sector, in Rp. Billions ...... 34
Annex 2 – Commercial Bank’s Outstanding Rupiah Credits (Total, Investment, Working Capital, by Group of Bank, Total and To Agriculture, in Constant Rp. Billions (1996=100) ...... 35
Annex 3 – Agriculture Sector Share of Total Outstanding Rupiah Credits Of Commercial Banks, by Group of Bank...... 36
IV. AGRICULTURAL COOPERATIVES IN INDONESIA ...... 37 Introduction...... 37 Principles of the Cooperative Movement ...... 37 Strengths and Weaknesses of Cooperatives...... 37 Roles for Government ...... 38 Recent Institutional Developments ...... 38 Cooperatives in Indonesia ...... 38 Operation and Efficiency of KUDs...... 39 Current Directions...... 40 Rural Credit Issues...... 41 Conclusion...... 42
V. FERTILIZER ...... 43 Fertilizer Consumption...... 44 Table 1: Indonesia - Domestic Fertilizer Consumption, 1975-1998...... 45 Fertilizer Production...... 44 Table 2: Indonesia - Fertilizer Use on Food Crop Sector Only, 1991-1997...... 46 Fertilizer Distribution...... 46 Fertilizer Prices and Subsidies ...... 47 Recent Policy Program...... 47 Table 3: Indonesia - Ratio of Floor Price of Paddy and Ceiling Price of Urea, 1984-1998...... 48 Table 4: Indonesia – Maximum Retail Fertilizer Prices 1987-1998...... 49 Recent Policy Responses ...... 47 Further Adjustments Planned...... 50 The Case for Market Reform...... 50
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Page No.
The Case for Privatization...... 50 Policy Reform Issues ...... 51 A Strategic Policy Reform Program...... 51 The Major Issues...... 52 Privatization of the Current Production Companies ...... 57 Policy Conclusions and Recommendations ...... 58 Fertilizer Policy Matrix...... 59
APPENDIX I - A PROPOSED NATURAL GAS PRICING FORMULA FOR THE FERTILIZER INDUSTRY...... 62 Table 5: Variable Natural Gas Pricing for Fertilizer Production. 63
VI. SEEDS: COMMERCIALIZATION OF THE SEED INDUSTRY...... 64 The Formal Seed Industry in Indonesia ...... 64 The Institutional And Regulatory Framework...... 65 Impact of Government Policy on the Seed Industry...... 67 Options for Commercializing the Seed Industry...... 70 Specific Recommendations...... 71
References...... 71
I. Rice Price Policy and the Restructuring of BULOG
In 1997 and 1998, Indonesia’s agricultural sector was afflicted by the El Nino drought. Rice production fell by 3.7 per cent in 1997 and 4.9 per cent in 1998. Secondary food crop output fell sharply in 1997, and only in the case of corn production was there a modest rebound in 1998. In mid-1997 the government sharply increased fertilizer and pesticide subsidies with a two-part pricing system that was introduced to subsidize the main fertilizers and pesticides used for food crops while selling those used in the estate sector at market prices.
To brake inflation and protect consumers, domestic food prices were held at an average 40 per cent below prevailing import parity prices from June 1997 to May 1998. Government imports of food were sharply increased, while agricultural market controls were broadened to include export and domestic market restrictions on cooking oils as well as other staple foodstuffs. The heavy subsidies for agro-inputs and agricultural products contributed to hoarding, shortages, and illicit exports.
From November 1997 to January 1998, the rupiah devalued from 3,648 to 10,375 to the U.S. dollar. This increased the import parity price for imported rice from just under Rp 1,000/kilogram to just under Rp 3,000/kilogram. Although the government had intervened heavily to maintain low rice prices, domestic prices began to creep upwards to world market levels. Domestic rice prices rose by 6 percent in January, 12 percent in February, 3 percent in March, and 4 percent in April of 1998. Even then, the domestic prices was still only 60 percent of the equivalent import parity price.1
Between April and June 1998, the rupiah devalued from 7,970 to 14,900 to the dollar. Global grain prices also tightened between January and June of 1998, pushing up the import parity price for rice to the equivalent of Rp 4,600/kilogram.
Despite an increase in domestic sales by BULOG from May to September 1998, domestic food prices climbed sharply higher. Average retail rice prices rose from Rp 1,623/kilogram in May to Rp 3,000/kilogram in September, rising by 22 percent in June, 11 percent in July, 15 percent in August, and 19 percent in September. These rapid hikes in food prices contributed to high rates of inflation, and by July and August of 1998 had priced basic foods beyond the reach of many low-income households.
From September to December of 1998, the exchange rate strengthened. The average bilateral rate of exchange to the dollar increased from 14,900 to 8,025. On global markets, grain prices also eased, bringing the import parity price for rice down to
1 Global grain prices for Thai 25 percent rice were $232 per metric ton in December 1997, $260 in June 1997 and $220 in December 1998. An additional $25 per ton and 8 percent for handling charges are added to compute an equivalent import parity price. The world market price for sugar (CIF London) rose from US$272 per ton in December 1997 to $302 in June 1998. During that same period, wheat (Australia White FOB) prices eased from $171 per ton to $145 per ton, corn (No. 2 Yellow Bangkok) prices fell from $133 per ton to $89 per ton, and palm oil prices (5 percent bulk Malaysian) fell from $566 per ton to $533 per ton. 2 approximately Rp 2,200/kilogram. Domestic rice prices gradually adjusted downwards, but were still some 25 percent higher than import parity levels at the end of the year.
By August 1998, the government had abandoned its “general food price” subsidy policy. A targeted rice subsidy program (the OPK program) was introduced to protect rice consumption levels of low-income households. In September, the government announced that BULOG would confine its agricultural market activities to rice and would dispose of its non-rice food stocks; meanwhile, the government liberalized trade in sugarcane, wheat, soybeans, and rice. In November the government abolished fertilizer subsidies, liberalized fertilizer imports, and announced that domestic fertilizer companies could make their own marketing arrangements. Domestic fertilizer prices quickly adjusted upwards to world market prices. To offset higher fertilizer prices, the government increased subsidized credit for food crops production, lowered agricultural lending rates from 12 to 10.5 percent, and forgave payments on pre-1996 agricultural loans. To further boost rice production, the government raised the paddy floor price by 50 percent to Rp 1,500/kilogram in January 1999 and introduced a regional system of floor prices for paddy.
Rice prices declined by 10 percent from their September 1998 peak after untargeted rice subsidies were removed, and should continue to decline. The weather in 1999 has been better than in 1998, public stocks are adequate, and import prices are lower than last year. Rural communities appear to have been hit less hard by the crisis than urban households. Nevertheless, rural wages for laborers and farmers’ incomes remain under pressure, particularly for the landless and land-poor. As of March 1999, only the rice subsidy scheme (the OPK program) was having a significant effect in rural areas. Meanwhile, the switch from a low and subsidized output and agro-input pricing policy to a market-oriented agricultural pricing policy for all agricultural commodities has yet to be fully implemented.
Policy Challenges and Constraints
The narrowing of BULOG’s mandate to rice left the agency with large stocks of wheat, sugar, soybeans, and other foodstuffs, but attempts to sell these stocks have been frustrated by weak domestic demand and the availability of imports at a price well below BULOG’s procurement price. Although rice trade has been liberalized and rice tariffs are to be fixed at 5 percent, the government is still attempting to use a floor price and market operations program to support producer incomes and stabilize consumer prices. The government has failed to understand that prices cannot be free to follow the movements of world markets while being kept stable domestically.
Rice, of course, is far too important a commodity in Indonesia to allow hasty and inconsistent changes in policy. The country needs to seek a comprehensive and thoughtful solution to these issues. In the near term the government must focus its attention on ensuring that basic food requirements are met. Thereafter, the main challenge is to
3 stimulate economic recovery. Agriculture, as one of the least distressed sectors of the economy, offers considerable hope for the future. Within agriculture, rice production offers significant scope for growth, employment generation, and productivity improvement. Priority should be accorded to crafting incentives conducive to sustained agricultural growth and rural development. Within this broader framework, there are a number of possible options.
At the one extreme, the government could abandon all efforts to stabilize domestic rice prices, abolish the public procurement and distribution system, and rely solely on private trade. This would entail certain risks, the most notable being whether domestic producers and consumers would be willing to accept the consequences of considerable price volatility.
Another option would be to restore the government’s monopoly on rice imports and return to its pre-1998 rice price stabilization policy. The disadvantage of this policy is that monopoly confers economic rents, which inevitably produce waste, corruption, and nontransparent behavior.
This policy note proposes that government retain many of its traditional rice policy objectives while implementing them in a more transparent and cost-effective manner. Possible near- and medium-term options are given in Table 1.
Farm Income Support
Historically, the government has tried to protect rice farmer incomes.2 Since demand is price-inelastic and shocks primarily affect domestic supply, government attempts to stabilize producer prices tended to stabilize farm incomes and improve the environment for agricultural innovation.
But the raising of the paddy floor price from Rp1,000/kilogram to 1,500/kilogram in December 1998 set the price at a level that was more than 30 percent higher than the prevailing import parity price. As a result, BULOG found it difficult to procure paddy in the first quarter of 1999. Although the agency has enough credit to buy nearly 1.8 million metric tons on the domestic market, it is doubtful that it will be necessary to procure so much to keep farm prices firm. A combination of a smaller than expected crop, a buildup of farm stocks, and wet weather has kept prices high.
Although there is merit in using a floor price scheme to protect farm incomes, certain principles should be adhered to. The floor price should be a minimum guarantee price, and BULOG should act as the buyer of last resort. Accordingly, the floor price
2 Protecting farm incomes is a legal obligation of the Indonesian government. Law 5 of 1992 (Undang-Undang Dasar 5) states t hat government will endeavor to ensure that farmers who participate in government programs receive a good income.
4 should not be set above expected world market import-parity prices, adjusted for expected inflation.
At present, there are few channels for transferring income to small rice farmers other than agro-input subsidies. Over time, however, it may be possible to develop institutional mechanisms to support producer incomes, without distorting prices. Block grants to rice-producing villages, for example, might be explored as an alternative to floor price protection.
The effectiveness of an appropriate floor price hinges on the effectiveness of domestic procurement operations. The objective should be to defend the floor price in a commercially viable manner, with clear criteria for qualified suppliers of public stocks. Procurement credit should only be channelled through qualified suppliers. Preferential terms for cooperatives and nongovernmental organizations should be phased out.
In the medium term, the government should consider developing other programs to protect farmers from the risks of postharvest price declines. One option would be to create a warehouse receipts system, in which farmers would pre-sell a portion of their crop and use warehouse receipts as collateral to finance future production.
Targeted Rice Distribution
By the end of 1998, after six months of implementation, the OPK program was providing a monthly rice ration of 20 kilograms per family to approximately nine million households at more than 30,000 distribution points. Although the program was designed as an emergency relief measure, it offers an alternative to rice price stabilization.
In the near term, however, the challenge is to sharpen the cost-effectiveness of the program: to concentrate more of the assistance in urban areas, tighten eligibility criteria, increase public awareness, improve beneficiary reporting, and ensure that the program is extended and placed on a financially sound footing. To reach the large numbers of excluded urban poor, the government plans to involve NGOs in the distribution of subsidized foodstuffs. A better public/private partnership in relief distribution could extend the reach of the OPK effort as long as strict standards of program accountability are maintained.
The crisis has drawn attention to the fact that assuring food security is largely an incomes problem, that income levels can change rapidly, and that even some of the most prosperous parts of the country have large numbers of households without food security. A variety of data sources could be used to monitor food security status and to design appropriate medium-term measures for providing assistance to vulnerable households. These might include some combination of targeted OPK effort, ration shops, village granaries, food stamps, and subsidized food stalls.
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Price Stabilization
Prior to mid-1998, the government intervened in the domestic rice market to stabilize prices because the world rice market is thin and subject to severe short-term price volatility; because the food security status of low income consumers is highly sensitive to changes in the real rice price; and because farm incomes, labor demand, and innovation hinge on a stable planning horizon. None of these conditions have changed. In fact, deepening poverty and three years of below-trend rice production suggest that rice price stabilization may be more important than ever.
Up to April 1999, there had been a lively debate about the influence of rice imports on farm gate prices, with BULOG authorities insisting that only high-quality rice has been imported and the Ministry of Agriculture insisting that lower grades had been imported. Since substitution elasticities in rice are rather high, the issue was more one of quantity than quality. Data on private imports suggest that these were on the order of a mere 120,000 tons for the first quarter of 1999.
The government should exercise caution before abandoning its rice stabilization objectives, since the global rice market is considerably more volatile than Indonesia’s controlled domestic market. The government must decide what level of price instability is socially and economically acceptable. Attempts to stabilize prices involve direct and indirect costs and benefits. The different approaches also imply different configurations of administrative effort. A high priority should be attached to evaluating the costs and benefits of alternative stabilization measures to help inform public policymakers about the trade-offs involved in different approaches. EKUIN (with the financial support of the USAID) is mounting a series of studies on the options. Maintaining some degree of price stability without excluding private trade should be the ultimate goal.
In a more liberal trading environment, rice exports as well as imports should be allowed. Otherwise, consumers would benefit from low global prices while producers would be excluded from the benefits of higher global prices.
The costs of price stabilization could be reduced if BULOG were able to lower its storage and trading costs. This implies that BULOG may need to undertake more frequent market operations and to utilize options and other financial instruments to hedge risks and reduce its costs. BULOG should conduct its operations through wholesalers and traders who meet established commercial performance criteria.
Public Stocks
The government maintains public rice stocks of between 2 to 3 million metric tons as a buffer against possible disruption in world market trade. With just over 2,400 grain warehouses, the government has the largest network of food storage facilities in the country.
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But private demand for BULOG’s stocks is limited, and the government has not authorized BULOG to release its non-rice food stocks at a loss. Without flooding the market, BULOG’s non-rice food stocks should be sold off, and the proceeds used to reduce the agency’s debts.
The government could also improve its stockpile policies by reducing the volume of rice stocks it holds and managing its stocks in a more efficient manner. At present, the government provides monthly rice rations to civil servants, police, the military, and other groups. The government holds nearly 1.2 MMT in rice stocks to meet the needs of these groups, and the rations will continue to be needed because many civil servants and security personnel are now badly off. But as the economy recovers the government should gradually monetize this food ration, and in so doing, reduce the size of its rice stock.
Rice Market Development Policy
The rice trade operates according to local market practices and traditions. Government agencies provide some price information, and grading systems reflect local tastes and preferences. The government could reduce transaction and search costs if uniform grades and standards were introduced and an effort were made to release additional market information. Access to market information will become more important as global market developments influence domestic price formation.
Little of BULOG’s up-to-date information on local and global rice market developments is released to the public. Broader access should be provided, using a web site or other mechanisms. In the medium term, the government should also work with the private rice industry to develop a system of grades and standards.
Since the early 1970s, a permit system has been used to restrict the size of rice milling operations. The promotion of small-scale, labor-intensive rice milling operations was deemed appropriate in light of rural underemployment and capital subsidies that biased the choice of technology. But if Indonesia is to compete on global markets, the private rice trade should be free to select the most appropriate milling technology. Over time, phasing out milling permit requirements would help to lower rice marketing costs.
BULOG Restructuring
BULOG’s loss of its monopoly import authority for non-rice crops has cost the agency dearly. The income generated from those crops was often used to cross-subsidize losses in its rice market operations. The agency has large debts, owns none of the assets that it uses, is established more on a provincial-cum-administrative rather than commercial basis, and relies principally on subsidized government credits to fund its rice procurement
7 and market operations. As the scope of BULOG’s activities narrows, the agency finds itself with excess capacity in both staff and physical facilities.
BULOG has been used to provide competition to the private trade, even if this occasionally meant undertaking loss-making operations. A recent example is the arrangement under which BULOG purchases cooking oil and provides it to the Indonesian Food Cooperative for resale to a network of urban distributors. The latter has accumulated large arrears to BULOG because of difficulties in penetrating the private cooking-oil markets.
A team of external auditors from Arthur Anderson is examining options for improving the efficiency of BULOG’s activities, and the audit was to be completed in May of 1999. The hope was that this audit would identify ways in which BULOG’s structure, organization, financial management, and operating procedures could be put on a commercially sound footing.
BULOG has also prepared an internal review of its future restructuring options, and staff team has recommended that the agency be split into two branches---a public service branch to handle rice market operations and a commercial branch with authority to trade in a variety of foodstuffs on equal terms with the private sector. The report also recommends that operational decision-making authority be progressively delegated to the regional offices of BULOG, with the central office providing policymaking and oversight services.
There is little reason for a publicly-owned commercial trading business. But if BULOG is split into commercial and public service branches, the commercial subsidiaries should be required to pay rent for use of the government’s commercial grain-marketing assets and pay corporate taxes. If an appropriate rent were charged and taxes levied, it is hard to imagine that BULOG could provide competitive food-marketing services, or that commercial and public service wings could exist within the same organization. The temptation to transfer costs and revenues between the two operations would be too great. The commercial subsidiaries would therefore have to be separated from BULOG as a whole. In practice, however, that would involve splitting up warehouse complexes and transport fleets. One could easily imagine the commercial wing getting the best storage and marketing assets and the public-sector rice-mission wing inheriting the leftovers.
Ideally, the government should define its rice policy regime first and then restructure BULOG. That restructuring should be undertaken in a manner consistent with the objectives that the agency is mandated to provide. If government decides to rely solely on private rice trade, the appropriate response would be to privatize BULOG in orderly fashion.
Whatever is decided, the agency could operate more efficiently and effectively if it were operated in a more transparent and commercial fashion. A number of measures would need to be taken, including restructuring of the balance sheet, a reorganization of the agency’s operations along commercial zone (rather than administrative boundary) lines, implementation of commercial salary scales and operating procedures, and disposal of
8 excess physical assets. Transforming BULOG from a “logistics board” into a “logistics company” (as a state enterprise) would be a logical first step toward either privatization or more efficient public implementation of rice market policies.
Table 1: Rice Policy: Short and Medium-Term Reform Options
Policy Issue Objective Near-Term Reform Medium-Term Options Reform Options Farm Income Support To stimulate agriculture development by Guaranteeing The rice floor price Examine options for minimum prices and should be used as a introducing producer keeping the rice minimum guarantee income support that is market contestable to price and BULOG WTO consistent and stimulate productivity should be the buyer of delinked from price growth and smooth last resort. The price support producer incomes should not be set above expected world market equivalent paddy prices adjusted for expected inflation Operating the public Procedures for public Alternative means of rice procurement procurement need to stimulating private program in a sound, be placed on a price stabilization commercial manner, commercial basis, should be explored, and encourage with clear criteria including, for efficient farm-level defined for qualified example, a warehouse stock holding suppliers of public receipts system stocks. Procurement credit should only be channelled through qualified suppliers. Procurement price premium for the coops should be phased-out Targeted food Protect Minimum Expand urban Prepare a food subsidies Food Consumption coverage, partly by insecurity monitoring Levels of the Poor adding a NGO-based system, either built on subsidized rice the BKKBN data or distribution effort in on UPGM measures urban and peri-urban slums Limit eligibility Examine alternatives criteria to BKKBN for targeting indicators that capture assistance to food household food insecure households insecurity after the OPK program concludes. Such alternatives
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might include a more targeted OPK effort, ration shops, village granaries, food stamps and subsidized food stalls Extend program duration for the 1999/2000 fiscal year Mount a public information campaign, establish a dispute resolution mechanism and improve reporting on beneficiaries reached Price Stabilization Maintain a level of BULOG’s price price stability for rice stabilization mandate that can reduce risks to be limited to rice for consumers, producers and traders Enforce the Liberalize rice exports September 1998 regulations which allow general importers to import rice Assess the possibility of a shift to a variable levies system to help stabilize domestic rice prices BULOG to be authorized to undertake more frequent market operations and to utilize options and other financial instruments to reduce costs and enhance domestic price stability Stock distribution should be provided to bonafide distributors only Public Stocks Public Stocks should Sell off the non-rice Gradually reduce the be managed stocks of BULOG by provision of rice efficiently and should a target date through rations to civil protect the country sales to qualified servants to reduce
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protect the country sales to qualified servants to reduce from unexpected private wholesalers public stock supply and import and processors requirements availability shocks Rice Marketing Policy Enhance the BULOG to establish a Establish an information quality of information release appropriate set of the private rice market and outreach effort grades and standards for privately traded rice Deregulate the permit requirements for rice mills, and encourage construction of modern, cost-effective mills BULOG Management Ensure that the rice BULOG’s mandate to Design a plan for and Tasks policies listed above be limited to rice corporatizing are implemented as market operations BULOG: The plan efficiently and should address effectively as possible BULOG’s balance sheet, and the structure, organization and management of BULOG operated as a commercial entity Arthur Anderson Restructure BULOG review of financial to shed excess assets efficiency to be completed by May 1999 CIDA study of rice As a commercial market policies and entity, BULOG restructuring options should enter into to be completed annual performance contracts with the government to satisfy public rice policy tasks EKUIN studies on After BULOG is rice policy options to operating successfully generate information as a commercial rice- for making informed policy implementing policy choices on rice enterprise, establish a stabilization plan for privatizing approaches BULOG
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TABLE 2: RICE - AREA HARVESTED, PRODUCTION, AND YIELD, 1982 - 1998
Year Area Average Paddy Rice Growth Harvested Yield Output output /a (%) (‘000) (tons/ha) (‘000 tons (‘000 tons) ) 1974 8509 2.64 22464 15276 1975 8495 2.63 22331 15185 -0.6 1976 8368 2.78 23301 15845 4.3 1977 8360 2.79 23347 15876 0.2 1978 8929 2.89 25772 17525 10.4 1979 8850 2.97 26283 17872 2.0 1980 9005 3.29 29652 20163 12.8 1981 9382 3.49 32774 22286 10.5 1982 8988 3.74 33584 22837 2.5 1983 9162 3.85 35302 24006 5.1 1984 9764 3.91 38134 25933 8.0 1985 9902 3.97 39033 26542 2.3 1986 9988 4.00 39726 27014 1.8 1987 9923 4.04 40078 27253 0.9 1988 10138 4.11 41676 29340 4.0 1989 10531 4.25 44726 29072 2.6 1990 10502 4.30 45179 29366 1.0 1991 10282 4.35 44689 29048 -1.1 1992 11103 4.34 48240 31356 7.9 1993 11013 4.38 48181 31318 -0.1 1994 10734 4.35 46641 30317 -3.2 1995 11439 4.35 49744 32334 6.7 1996 11569 4.41 51101 33215 2.7 1997 11141 4.43 49377 32095 -3.7 1998 11613 4.17 48472 30537 -4.9 1999 RI 11494 4.23 48663 30657 0.4
a/ Estimated on the basis of a conversion factor of 0.68 from paddy into rice for the years prior to 1989, and a factor of 0.65 for the years 1989 and following. 1998 refers to the third forecast. For 1998, the milling yield was reduced to 0.63. Source: Ministry of Agriculture, Bulletin Informasi Agribisnis, Oct-Dec 1998, 1998 and Department of Statistics, Third Production Forecast, 1998.
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Table 3: Food Price, Consumer Price, Exchange Rate, and Rice Price in 1998
Month Food Consumer Rupiah to % Change in Average % Change Price Price US$ the Rp/US$ Rice Price in Index, Index, Exchange Exchange in Major Medium 1996=100 1996=100 Rate Rate Cities Rice (Rp/kg) Prices
June 1997 104 105 2,450 0.4% 1,033 1.2% Nov. 1997 117 110 3,648 -0.1% 1,207 7.48% Dec. 1997 121 112 4,650 27.47% 1,215 0.66% Jan. 1998 133 120 10,375 123.12% 1,290 6.17% Feb. 1998 158 135 8,750 -15.66% 1,439 11.55% Mar. 1998 167 142 8,325 -4.86% 1,475 2.50% April 1998 177 149 7,970 -4.26% 1,532 3.86% May 1998 183 157 10525 32.06% 1,623 5.94% June 1998 196 164 14,900 41.6% 1,988 22.5% July 19 98 220 178 13,000 -12.75% 2,202 10.8% Aug. 1998 240 189 11,075 -14.8% 2,529 14.8% Sept. 1998 261 196 10,700 -12.42% 3,009 18.9% Oct. 1998 256 196 7,550 -29.4% 2,828 -6.0% Nov. 1998 256 196 7,300 -3.3% 2,830 0.0% Dec. 1998 263 198 8,025 9.93% 2,758 -2.5%
Source: Bank Indonesia and BULOG.
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II. ALTERNATIVE FOOD SECURITY INSTRUMENTS:
THE WAREHOUSE RECEIPTS SYSTEM
A warehouse receipt is a transferable title of ownership of goods stored in a certified warehouse. The receipt describes in precise terms the quantity and quality of goods stored. The warehouse that issues the receipt guarantees the safekeeping of the goods and is obliged to maintain the quality of the goods within prescribed limits. The warehouse also guarantees that the information contained in the receipt is accurate. For Indonesia, a warehouse receipts system (WRS) has three potential uses: (a) Warehouse receipts can be used as the mechanism that substitutes for physical delivery of goods under contract for delivery to the ICEB.
(b) Warehouse receipts can be used to facilitate and formalize domestic trade in commodities by serving as transferable collateral and thus facilitating trade financing.
(c) Warehouse receipts can serve as a less intrusive and market-based instrument for government intervention in markets that takes the form of control over inventories.
Exchange Delivery
Most commodity exchange contracts, including contracts being designed for the ICEB, contain provisions on physical delivery of the goods. In order to assure both the quality and quantity of the goods, and to minimize logistical problems, commodity contracts often specify that goods awaiting delivery to purchasers must reside in one of several warehouses named in the contract. Examples of commodity contracts include those from commodity exchanges in Argentina, Brazil, South Africa, the United Kingdom (UK), and the United States. In practice, delivering against a contract means transferring physical possession of the warehouse receipt. Therefore, as a practical matter, the ICEB will need to utilize something very much like a warehouse receipt system. This need not be an open system and could be established by agreement among members of the Exchange.
Facilitating Trade
Much of the commodity trade in Indonesia is based on informal working relations - - that is, most trading is done either on a cash-and-carry basis or depends on personal trust between buyers and sellers that has been established over time. Such systems can work
14 well, but they inherently generate some redundancies and are subject to limits -- for example, time spent on re-inspections of goods to assess quantity and quality. A warehouse receipts system, on the other hand, is a formal mechanism for insuring quantity and quality. It allows quick aggregation of same-quality goods for shipment and allows traders in different locations to swap inventories. In short, a warehouse receipts system allows traders to use paper in many activities that would otherwise require physical handling of the commodity itself. Formal financial institutions are generally cautious about making loans to operators in informal markets and therefore require loans to be covered by some form of collateral, such as equipment or buildings. In commodity trading, of course, the need for working capital rises and falls with crop seasons and the current value of the commodity. Using commodity inventories as collateral is a way to assure repayment to banks and to naturally adjust the level of credit to match seasonal needs. Commodity inventories have long been used as collateral in many countries. Such systems work best when they operate within an effective legal and regulatory framework that allows private storage. Warehouse receipts also standardize the form of the collateral, and thus lower transaction costs. Countries with more than 50 years’ experience with formal trading of warehouse receipts include Mexico, the Netherlands, the United States, the UK, and Venezuela.
Policy Instrument
Should the government of Indonesia decide to continue its management of rice stocks, a warehouse receipts system would provide a market-based instrument for enlarging or reducing inventories. Rather than handling actual stocks of rice, BULOG or another agency would simply buy, hold, and sell warehouse receipts for privately stored rice. It is important to note, however, that when a government decides to manage stocks -- regardless of how it does so -- public storage of the commodity may crowd out or even preclude private storage – an undesirable outcome.
Prospects for Developing a Warehouse Receipts System in Indonesia
The consultations with private and public groups indicate that conditions exist for developing a warehouse receipts system in Indonesia. Although such a system could be used for all three purposes noted earlier, the greatest benefits would probably come from the facilitating of commodity trade.
Banks Are Interested
Private banks in Indonesia, including ABN-AMRO, Citibank, and MessPierson, have indicated that they would be interested in lending against commodity inventories and have investigated how they might go about doing so. Some of the country’s banks currently make loans for commodity trading, but do so cautiously and with safeguards in addition to pledges of inventories. Concerns about clear title to inventories, access to
15 inventories, and contract enforcement have caused them to limit such lending. Insurance against country risk and performance risk is available, but when insurance costs are factored in, the interest rates on loans become impractical.
Intermediaries
Traders in Indonesia without access to overseas credit have difficulty in raising sufficient amounts of working capital. The requirements for working capital are large; a medium size coffee trader can easily accumulate inventories worth more than US$500,000. Exporters and their clients currently use quality inspectors and warehouse receipts as part of their payment mechanism, so many warehouse-related documents are already generated during normal trading practices. One trader described how he sold cash against documents:-- The buyer released funds as the trader delivered inventories into a warehouse he rented to his client and managed by an independent management company. Although warehouse documents can be used as receipts in the sale of inventories, traders cannot use such documents to support their requests for loans because banks are reluctant to accept them as collateral for the reasons given earlier.
Warehouse Management Companies
Two warehouse management companies in Indonesia, Sucofindo and BGR, have expressed a positive interest in the establishment of a WRS. Both have the capacity to implement such a system. Another company, Pan Asia, as well as numerous local warehouse companies specializing in a single crop, would probably enter the market as well.
Farmers’ Practices
According to Professor Tampubolon of the Center for Development Studies, BOGOR, rice farmers in Indonesia often hold stock in excess of what they require for home consumption, especially in uncertain times. And sometimes they establish informal inventory-holding agreements with rice millers. In principle, these informal arrangements could be made more formal. Producers of export crops like coffee, cocoa, and pepper generally do not hold inventories directly. Local cooperatives could hold inventories of export crops in exchange for credit. Most Indonesian traders do not anticipate significant participation by smallholders. However, the general belief of traders was that a more formal marketing system would benefit smallholders in three ways: (a) Standardized warehouse receipts would help improve quality standards and formalize local markets around warehouses, thereby improving price discovery, especially for rice and corn.
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(b) Farmers tend to receive the destination price for their commodities – that is, minus costs between the farmgate and destination. To the extent that markets are made more efficient and marketing costs are reduced, producers and consumers will benefit.
(c) To the extent that a warehouse receipts system increases competition among private storage companies, seasonal price variability will be reduced.
Coffee and Cocoa
Crop differences are likely to influence how warehouse receipts would be used in the market. Coffee and cocoa, for example, are primarily smallholder crops. After harvesting, the crops are collected by company agents and exported by a number of local and foreign-affiliated firms. Many exporters also operate warehouses, but medium-sized exporters that lack offshore partners to provide working capital are especially pressed by current high interest rates. Cooperatives operate warehouses and also play a role in aggregating supplies. Exporters, and potentially cooperatives, are the groups most interested in inventory financing.
Other Major Crops
Palm oil, coconut oil, sugar, corn, and rubber all require some form of processing before they reach the retail market. Usually, processors and refiners are exporters as well. In the case of cooking oils, the companies may be integrated businesses that process and sell cooking oils. The processing/exporting companies would be the most likely users of a warehouse receipts system. Vegetable oils must be bulked for export; and most exporters maintain warehouses at different locations. Consequently, small and medium-size exporters in particular see advantages in the quality assurances and paper trade that a warehouse receipts system would provide. In the case of sugar, rubber and to a lesser degree palm oil, public ownership may limit the ability of some processing facilities to finance inventory. Moreover, the sugar trade is only recently established. Traders active in other markets have now moved into sugar, a product previously controlled by the state. Corn trade is also new to most participants, but all of the groups interviewed during the mission felt that private trade was emerging rapidly.
The Rice Market in Indonesia
The rice market in Indonesia is at a crucial juncture. Rice is a staple produced by millions of smallholders, and while there was considerable private trade in the Indonesian market, BULOG controlled all exports and imports. In rural areas the market is largely informal; smallholders sell their rice to company agents or to small-scale processors. Large-scale urban processors then reprocess the rice, differentiating by quality, name brand, and package size. The large-scale processors compete with medium and small-scale processors and small shopkeepers compete with supermarkets. While BULOG
17 monopolized the foreign rice trade, it also participated to a relatively small degree in the domestic market For many years the government of Indonesia stabilized the domestic price of rice through inventory management in order to protect both smallholder incomes and consumer prices. Certainly, a warehouse receipts system could be used to manage domestic inventories of rice owned by private companies. Still, it should be pointed out that earlier experiences in Indonesia with private oversight of public inventories proved problematic. The use of warehouse receipts in the public management of inventories requires the same guarantees of performance required for inventory-based financing. A warehouse receipts system is only one possible approach to meeting the government’s policy objectives of stabilizing rice prices. The government could provide targeted income relief for both consumers and producers in the form of cash transfers. Another way to reduce the need to hold physical inventories would be to establish a system of contingent financial management -- for example, a contractual arrangement that provided the government with the option (but not the obligation) to purchase rice supplies from international markets at a given price. This would give the government the capacity to respond to emergency needs for rice without tying up resources in rice inventories.
Technical issues
The key components of a warehouse receipts system are: · A law pertaining to warehouse receipts and agency regulations that establish property rights to inventories and specify the conditions under which those rights can be reassigned; · Rules specifying the requirements for warehouses and arrangements for monitoring and enforcing WRS regulations; · Arrangements to ensure the financial integrity of the system. Performance could be guaranteed through private insurance, or some combination of private insurance and fee-generated indemnity funds supervised by public agencies; · It might also be necessary to establish rules to determine how bank loans backed by warehouse receipts would be handled in the internal bookkeeping.
Experience of Other Countries
USAID, through ACDI/VOCA, has sponsored the creation of warehouse receipts systems in Poland and Bulgaria, and EBRD is financing warehouse grain receipts in Slovakia along with Pol'nobanka, a private Slovakian bank. All three projects are in early stages and do not yet qualify as best practices. However, they do offer a promising design that might be well suited to Indonesia's needs.
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The projects have involved quick establishment of property rights while cautiously developing standards, monitoring mechanisms, and banking practices through pilot projects. Public and private participation beyond the pilot participants is being obtained by establishing advisory groups composed of representatives from commodity trade, the insurance industry, the banking industry, the warehousing and surveying industry, and the accounting industry. While the pilots have performed well from a technical standpoint, domination of the market by government purchasing agencies has caused problems for private storage firms, and there have been delays in drafting enabling legislation for the systems.
Recommendations
1. ICEB should develop formal ways of allowing trade associations, banks, the insurance industry, and warehousing and surveying companies to comment on the WRS. 2. ICEB staff should visit the pilot projects in Poland, Bulgaria, and Slovakia and discuss their progress with implementing agencies and industry participants. 3. ICEB should arrange for local and international financial consultants to: (a) draft a Warehouse Receipts Act; (b) draft supporting rules and regulations; (c) recommend appropriate bank regulations; and (d) design an appropriate guarantee facility. 4. ICEB should seek clarification from the Bank of Indonesia concerning the conditions under which warehouse receipts could be treated as loans against commercial paper, rather than as ordinary collateral. 5. ICEB should begin discussions with donors on establishing pilot projects in palm oil, coffee, and rice. USAID should be contracted because of its experience in other countries. 6. ICEB should have a clear understanding of the direction of the government’s rice policy and base the design of a rice pilot project on that understanding. 7. Joseph Dial, a former commissioner of the U.S. Commodities Futures Trading Commission (CFTC), should be asked to provide ongoing guidance about a warehouse receipts system during his visit at the ICEB. 8. The Bank should consider making an IDF grant in support of the institutional components of a warehouse receipts system.
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III. RURAL CREDIT
Indonesia’s policy on rural credit has changed dramatically since the onset of the crisis. Prior to the crisis, policy was guided by the principles of PakJan ‘90, (short for Paket Januari 1990): (i) credit allocation was generally to be determined by supply and demand; (ii) the use of liquidity credits from Bank Indonesia was to be narrowed to food self-sufficiency and the development of cooperatives;3 and (iii) interest rates should gradually move to levels determined by market forces.
This policy framework produced a consolidation of rural credit programs, which had ballooned to about 200. They were pared back to only four Bank Indonesia programs: farmer production credits (KUT); credit for members of primary cooperatives (KKPA); credit for food crop harvest and distribution (KKOP); and a small-scale enterprise credit program (KUK). Under the KUK, commercial banks were required to maintain a minimum of 22.5 percent of total outstanding loans as credits to KUK clients.
With the onset of the crisis, compounded in rural areas by a prolonged drought, GOI sought to use existing rural credit programs to move capital into the hands of small- scale farmers and rural entrepreneurs. But the commercial banking institutions relied on by PakJan ’90, and through which the KUK program had operated, were in serious financial difficulty and unable to respond quickly. GOI then instituted a number of changes in its policies, and a host of new subsidized credit mechanisms, which are described below. These mechanisms are being defined and implemented primarily by Bank Indonesia (through liquidity credits) and the Ministry of Cooperatives, Small and Medium-Scale Enterprises. At last count, there were 14 credit programs (including the four in existence prior to the crisis) that are being used to carry out a broad expansion of rural lending.
The GOI’s chief objective is to alleviate the immediate social consequences of the crisis. There is ready acknowledgement that the current policies are not a sustainable approach to rural credit development. Rather, current policies are presented as a necessary detour from PakJan ’90, which will be resurrected once the crisis is overcome.
Rural Credit Aggregates During the Crisis
Data limitations permit only a rough description of current lending for rural activities. There are four lending channels, which in declining order of importance are commercial banks, Bank Indonesia, Bank Perkreditan Rakyat, and informal credit institutions.
3 Bank Indonesia liquidity credits are made available to credit programs that serve various government objectives. This capital is made available to target groups through mechanisms that typically operate through a bank that either provides the onlending service for a fee or blends the capital with its own resources for approved credit operations.
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Where possible, this note focuses on all rural credit rather than on agriculture credit alone. On Java, for example, about half of farm household income comes from nonagricultural activity. These households’ borrowing needs and behavior can best be understood by understanding their management of credit resources for all activities.
The closest approximation of commercial credit to rural areas is credit to the agricultural sector as reported in Bank Indonesia’s aggregate statistics. Lending to rural activities in other sectors (trade, construction, etc.) is included in aggregates that include urban lending. Sector credit outstanding includes both rupiah-denominated and foreign- currency denominated credit. The rupiah value of the foreign currency loans has increased rapidly because of the devaluation of the rupiah, but that is better understood as an additional repayment burden rather than an increase in available credit. Foreign-currency credits to the agricultural sector have gone almost entirely to large-scale enterprises (estate crop plantations in particular), while rupiah credits go to both large and small borrowers.
Since the onset of the crisis, credit to the agricultural sector has declined by about 10 percent in real terms from its peak the previous year, to about Rp. 29 trillion. Over roughly the same period, the agricultural sector was the only sector that produced any growth in GDP, though by less than one percent. Despite its decline in real terms, agricultural credit as a share of total commercial bank lending has increased since mid- 1997 from 6.5 to 9.4 percent. The increase occurred because lending to other sectors has declined even more rapidly.
The commercial agricultural credit portfolio has deteriorated significantly. Investment credits have declined by over a third, while working capital has increased by almost two-thirds in real terms. Both lenders’ assessments of increased risks and borrower prudence in the face of higher interest rates are likely contributors to the decline. Although the decline in investment credit is not a good harbinger of agricultural growth, there is no evidence of a shortage of working capital. The value of nonperforming loans increased from 14 percent of total credit in May 1997 to more than 62 percent in December 1998. As a consequences, the value of the entire portfolio of commercial credit has slumped.4
The other three categories of rural lending are not included in Bank Indonesia aggregates but can be estimated from other sources. Since information on debt outstanding is only available for a broader set of rural activities, it is not strictly comparable to the figures in Table 1 on commercial bank lending for agriculture. Aggregate lending of these additional channels is roughly 41 percent of the lending by commercial banks to the agricultural sector. Bank Indonesia liquidity credits (KLBI)--capital to subsidized credit programs for such things as farmer production and crop procurement by cooperatives-- have expanded rapidly during 1999, primarily because of the farmer production credit (KUT) scheme. Liquidity credits for rural activities had climbed to Rp. 9.5 trillion by March 1999, almost a doubling from Rp. 5.3 trillion at the end of 1997, and the equivalent of about 32 percent of commercial bank lending to agriculture. Bank Perkreditan Rakyat
4 Because of the growth and magnitude of nonperforming loans, it would be preferable to focus on flow data (new credit) rather than outstanding credit, but flow data are not available.
21 are institutions that provide credit for agricultural and rural activities but are not formally classified as banks and hence are not included in Bank Indonesia’s
Table 1: COMMERCIAL BANK CREDITS TO AGRICULTURE
constant Rp. trillion (1996=100)
May 1997 May 1998 December 1998 Agricultural Sector Total 19.9 23.9 20.7 Rupiah 17.3 16.8 15.7 Foreign currency 2.6 7.1 5.0 All Sectors Total 323.1 359.7 263.4 Rupiah 259.3 195.6 167.5 Foreign currency 63.9 164.1 95.9 Non-Performinga/ Agriculture, % 14 38 62 All sectors, % 9 35 59 Loans Source: Bank Indonesia, Laporan Bulanan (PPKr) a Loan categories: special mention, substandard, doubtful, loss. monetary survey. Outstanding loans by these institutions totaled about Rp. 2 trillion at the end of 1998, down 13 percent in nominal terms from the previous year. A number of other institutions provide financial services but are not formally classified as banks. These include Lembaga Dana Kredit Pedesaan (LDKP) and Tempat Pelayanan Simpan Pinjam (TPSP), which are described below. The aggregate lending of these institutions is not reported anywhere, but is thought to be no more than 2 or 3 percent of commercial bank lending to agriculture. Farmers and other rural borrowers also have 22 recourse to credit provided by traders, money lenders, and extended family members, but there is no reliable way to determine trends in borrowing from these informal sources. Subsidized Credit Schemes The announced intention of the current 14 subsidized credit instruments that target rural activities is to provide Rp. 10.8 trillion to cooperatives and SMEs.5 That would be a massive increase when compared with previous years. The chief instrument (KUT) provides highly subsidized production credit to farmers through cooperatives and NGOs, for which the target is Rp. 6.5 trillion (see Table 2). The cost to the government will be very high. Given current interest rates and repayment rates, the total annual cost of the three largest programs to the government is estimated at Rp. 3.5 trillion. That is 5 percent of GOI’s total development budget for 1998-99, 11 percent of the national deficit (IMF definition), and 2 percent of agricultural sector GDP. In reality, however, the cost is certain to be higher, due to the rapid expansion of the KUT, the loosening of eligibility requirements, and the increased risk of defaults by borrowers. Table 2: Bank Indonesia Rural Credit Programs Program Purpose Liquidity Credits, Rp. billions Feb. 1998 Aug. 1998 Feb. 1999 KUT - Kredit Usaha Tani To increase farmers’ production and 286 286 3309 incomes KKOP – Kredit Kepada Koperasi To provide working capital and 87 71 145 investment capital to cooperatives for the procurement and distribution of food commodities, and post-harvest financing KKPA – Kredit Kepada Koperasi To provide working capital and 1373 1521 1928 Primer untuk Anggota investment capital to cooperative members in all sectors of the economy Perkebunan /a Credit to smallholder tree crop 3637 3735 3822 producers as part of nucleus estate crop schemes PKM – Proyek Kredit Mikro To increase incomes, overcome 9 41 83 poverty, and increase women’s role through village microenterprises KMK BPR – Kredit Modal Kerja To increase ability of rural banks to 0 0 85 dalam rangka Pengembangan Bank extend loans to customers Perkreditan Rakyat Source: Bank Indonesia /a PIR, PIR Trans, PSN, PIR Trans Pasca Konversi. 5 Eleven of the schemes are funded by Bank Indonesia and are implemented with the Ministry of Cooperatives: KUT, KKOP, KKPA, KKPA-profit sharing, KKPA-TR, KKPA-PIR, KKPA-Nelayan, KKPA-Unggas, KMK-BPR/BPRS, KPKM-BPR/BU, and PKM. In addition, the Ministry of Cooperatives operates several schemes with different sources of funding: KPTTG, KMK UKM, and KPT – PUD. 23 Table 3: Subsidy Costs BI Rate Market Projected Interest Projected Rate Portfolio Subsidy Provisioning /a (billion Rps) KUT 10.5% 35% 6,500 1,593 1,251 KKOP 10% 35% 145 36 16 KKPA 9% 35% 1,928 501 96 Total 8,573 2,130 1,363 Source: Bank Indonesia /a July 1998 provisions on the KUT portfolio of Rp 400 billion were Rp 77 billion, or 19 percent, which is used for the KUT projection. Changes in the KUT Program Radical changes in the KUT (farmers production credits), the past year raise serious concern about its sustainability. The target amount to be lent for 1999 in nominal terms has increased 17-fold from previous annual amounts. Meanwhile, all nonperforming KUT debts from the 1985-95 period were forgiven and overdue payments in the intervening period were rescheduled.6 As a consequence of the write-off, many previously ineligible KUD have become eligible, and the implementation of KUT through “executing” banks that assumed the risks of lending has been changed to implementation through “channeling” banks that assume no risk. Moreover, collateral requirements have been considerably loosened. The current attempt to expand the KUT program has produced implementation difficulties, and more can be expected, for the following reasons: · Credit was mobilized late in relation to crop seasonality, and when credit did become available, the main purchased input (fertilizer) was scarce in local markets. · There are credible reports of instances where documentation of demand for KUT credit is inflating actual demand,7 with the amount of overstated credit being diverted to time deposits paying interest at about 25 percentage points above the subsidized cost of the credit. 6 Rp. 117 billion was written off, or approximately 15 percent of KUT lending during 1985-95. It is estimated that approximately 70 percent of this “nonperforming” portfolio amount was paid back by farmers to KUD but not subsequently repaid to Bank Indonesia. 7 An additional problem can be seen in the number of submissions (RDKK) for KUT by farmer groups where all individual farmers’ applications are for precisely one or two hectares, with no noninteger farm sizes. This oddity was explained as being the result of rounding off of farmers’ actual requests to facilitate provision of in -kind units of inputs that were difficult to divide for partial hectare units (sacks of fertilizer, bottles of pesticide). So the “need” to deliver credit in kind by KUT administ rators means that farmers do not get inputs in the amounts they need. 24 · In past years, all requests for KUT by farmer groups were reviewed for accuracy by Bank Rakyat Indonesia (BRI) which also assumed a portion of the risk of nonperformance. This year, accuracy will depend on reviews by inexperienced monitors and sample reviews by the Kabupaten Cooperatives Office. · Because no risk assessment is taking place, and expectations of future debt forgiveness were created by the cancellation of 1985-95 indebtedness, future repayment performance may be worse than the already poor repayment rate of about 70 percent of recent years. · Repayments on KUT loans for the 1998-99 rice crop do not normally become due for one year; hence, nonperformance will not be documentable until the beginning of 20008. · Past experience is that repayment by farmers of KUT credit to their village cooperative (KUD) is often more than what the KUD pays back to the servicing banks; that may be exacerbated under the current set-up. · Technical assistance by BRI staff to KUD on management of KUT credit is being curtailed. · The contracts of about 5,000 recent university graduates who were mobilized to facilitate and monitor the enlarged KUT program ended in March 1999. They were thus active in the scaling-up of credit but are now gone, when repayment has become the center of attention. Indirect but potentially negative effects of the changes in KUT have been created or exacerbated: · The availability of highly subsidized credit provides an incentive for the opportunistic creation of new cooperatives to get access to this credit; · In many localities, subsidized credit for inputs is delivered in kind to farmers through KUD, which retain preferential access to fertilizer supplies. Although the majority of farmers buy their inputs from the private market, the KUT mechanism isolates a portion of the fertilizer market and thus reduces the market for private sector sellers of fertilizer. · The program raises the risk that sustainable credit programs will be supplanted by an unsustainable one. Some managers of commercial rural credit programs do not see this as a problem, however, since they see the KUT as an instrument for enhancing productivity and income among farmers. A number of positive aspects of the KUT program can also be highlighted. First, it is clear that farmers needed credit to plant the 1998-99 rice crop, since they had drawn down their savings in trying to deal with drought. Second, there has been a substantial increase in the number of borrowers, whose use of agricultural inputs is resulting in better yields. Third, the hiring of the 5,000 program monitors and the use of NGOs to channel KUT credit has made it possible to lend to many farmers who had not previously been 8 In several of the Kabupaten offices that we visited, local officials were permitting farmer groups to submit for another round of KUT for the second crop season, but only on condition that the first round had been repaid. 25 organized to participate in loan programs.9 The monitors and the NGOs are handling the transactions whose cost had dissuaded banks from trying to reach those farmers. Commercial Programs of Rural Credit A number of rural credit institutions operate on essentially commercial terms. These include the BRI’s KUPPEDES and the lending institutions grouped under the name Bank Perkreditan Rakyat (Bank Kredit Desa and non-BKD, Gerakan Koperasi Kredit Indonesia, Lembaga Dana Kredit Desa, and Tempat Pelayanan Simpan Pinjam-KUD). Table 4: Commercial Rural Credit Programs Number of Total Average Loan Village Branches Outstanding Loan Size, Rp. million Amount, Rp. Billion Bank Rakyat Indonesia (BRI) 3700 4,627 1.85 Unit Desa Bank Perkreditan Rakyat (BPR) 1.22 Bank Kredit Desa (BKD) 5345 122 /b Non-BKD 2262 1,875 /c Gerakan Koperasi Kredit 1262 120 /b Indonesia Lembaga Dana Kredit Pedesaan 1782 n.a. 0.60 (LDKP) /a Tempat Pelayanan Simpan 1582 28 Pinjam-KUD (TPSP-KUD) Source: BRI, BI, PHBK /a LPD (Bali), KURK (Jatim), LKP (Lombok), LPN (Sumbar), BKK (Jateng, Bengkulu, Kalsul, Pekanbaru), LPK (Jabar), LKP (NTB), LKK (Aceh). /b Through December 1998. /c Through September 1998. The largest and most established rural credit program is KUPPEDES. This program of lending by BRI through village units to rural individuals for small-scale trading, enterprise, and agricultural activities has remained stable despite the crisis. KUPPEDES had Rp. 4.6 trillion of outstanding loans in January 1999, with payment arrears of less than 2 percent. Outstandings have been relatively stable (in nominal terms) for over a year, while savings at BRI’s village units have almost doubled. Outstandings are not growing primarily because the activities of clients have slowed down. Clients 9 The NGOs are being selected from a group of some 700 NGOs involved in community development that are members of the consortium Badan Kerjasama LSM Program Peningkatan Produksi Pangan dan dampingan Koperasi (BKS-LP5K). 26 appear to be operating at a slow pace and putting their capital into savings rather than into their businesses. The impact of KUT and the other new subsidized lending schemes on KUPPEDES is not thought to be great. Most clients apparently prefer the working relationship that they already have with BRI to involvement with KUD. Clients who do take part in KUD keep their transactions quite separate from their transactions with the BRI village units. A number of other rural credit institutions reach a poorer clientele than KUPPEDES and provide smaller loans, on average. People’s Credit Banks (BPR-Bank Perkreditan Rakyat), of which there are about 2,200, have outstanding credits of over Rp. 2 trillion to small-scale activities. About 500 BPR take part in a program to provide group credit. Village Credit Banks (BKD-Bank Kredit Desa) are village-owned and have a long tradition. There are more than 5,300, mostly on Java, with total outstanding credits of about Rp. 125 billion. TPSP-KUD, a banking activity through KUD with BRI supervision, has about 1,500 units with Rp. 28 billion of outstanding loans. The Gerakan Koperasi Kredit Indonesia (Indonesian Credit Union Movement) began operations in 1970 and has grown to 1,262 local credit unions, 28 provincial chapters, and a national office. Prior to 1998 the GKKI operated on an informal basis, since its member credit unions were not officially recognized. Outstanding loans are about Rp. 120 billion, with capital raised entirely from member savings. Credit policy is determined by individual organizations. Interest rates range from 24 to 36 percent, and loans are typically for one year and less than Rp. 3 million. About half of the individual credit union members are women. The national office provides interlending/liquidity pooling and life insurance that credit unions can require borrowers to purchase. Another rural credit group is the Lembaga Dana Kredit Pedesaan (LDKP), whose 1,792 offices go by different names in different parts of the country. 10 These are not banks, although they are regulated by a 1992 law which specified an upgrading of their capital and their institutional capacity. If they did not operate at a loss for at least three years, they would qualify to become BPR, with a deadline of October 1998.11 Only 132 LDKP managed to do so, while the rest remain in existence but in regulatory limbo. No central agency collects statistics on the LDKP, which report to (and are audited by) regional governments and regional development banks, the major owners. In addition, there are several micro-credit programs based on group lending. The main ones are Proyek Hubungan Bank dengan KSM (PHBK), overseen by BI with GTZ technical assistance, Pusat Pelayanan Kredit Koperasi Pedesaan (PPKKP), a project with Bank Bukopin and Rabobank, and Proyek Pembinaan Peningkatan Petani Nelayan Kecil 10 LPN (West Sumatra), BKK (Central Java, Bengkulu, S. Kalimantan, Pekanbaru), KURK (East Java), LPK (West Java), LKP (NTB), LKK (Aceh), LPD (Bali). 11 Presidential Regulation No. 71/1992, which implemented the 1992 Banking Law, stipulated that all small financial institutions that accept deposits were required to become BPRs or cooperatives by 1997. The minimum capital of Rp. 50 million necessary to become a BPR is a difficult requirement for small financial institutions. The regulation exempts institutions founded before 1992 or allows them to convert without satisfying the minimum capital requirement. Although implementation of the regulation appears not to be enforced under the current economic circumstances, it does appear to have hindered the development of microfinance institutions. Some microfinance institutions are attempting to comply with the regulation by not accepting deposits, which limits their growth and sustainability. 27 (P4K), a Ministry of Agriculture project with IFAD. These programs have grown rapidly, but total outstanding credits are relatively small (see Table 5). Table 5: Micro-Credit Programs Number of Participating Number of Beneficiaries Outstanding Credit, Rp. Groups Million December Mid-1998 December Mid-1998 December Mid-1998 1994 1994 1994 PHBK/a 1,887 15,403 77,000 629,640 16,286 119,205 PPKKP/a 1,881 2,038 113,992 128,640 23,000 125 P4K/a 35,417 49,927 354,170 499,270 39,639 135,246 Source: Bagian PUK, BI for PHBK; Urusan Kredit Kecil, Bank Bukopin for PPKKP; Departemen Pertanian for P4K. a 1998 data through April, July, and August for PPKKP, P4K, and PHBK, respectively. Policy Conclusions and Recommendations Rural credit policy is undergoing rapid changes that make it difficult to assess the pace and direction of rural lending. It is evident that commercial credit to the agricultural sector and to small-scale rural activities for investment has declined in real terms over the past year and is not sufficient to enable agriculture to play the role of leading sector. The government’s subsidized credit schemes are providing farmers with the capital needed for food crop production and rice procurement. The credit is undoubtedly helping farmers who were cash-strapped as well as underpinning public procurement of paddy to supplement the private rice trade. Filling the breach caused by declining commercial credit is to the benefit of small-scale farmers, since commercial credit is weighted toward a larger scale, business clientele, including estate crops. The scale-up of subsidized public credit, however, entails a costly interest rate subsidy, a shift away from the private institutional intermediation that favors sustainable implementation, and an unknown future in terms of repayment performance. Any favorable short-term impacts are likely to decline over time, followed by an increase in disincentives to the development of sustainable private credit programs for small-scale clients. The challenge is to define a return from the current subsidized approach to a policy of long-term commitment to small-scale commercial lending. A return to giving priority to developing commercial credit is not yet firmly defined in government policy, although elements of such a return are visible. The government is currently examining: (i) commercial lending practices to cooperatives and small- and medium-sized enterprise; (ii) the transformation of BRI into a specialized bank with a mandate to lend only on commercial terms; (iii) simplification of the directed credit schemes currently underwritten by Bank Indonesia and expected to be transferred to some other institutional mechanism (see below); and (iv) ways to establish positive interest rates. 28 The GOI anticipates maintaining a high level of farm credit while reinstituting risk-sharing with financial intermediaries and tightened eligibility requirements for borrowers in arrears. What would benefit from immediate attention would be a revision of KUT policies so as to minimize financial leakage, maximize the impact of credit on farmer productivity, and develop sustainable, seasonal credit for small farmers. KUT is not sustainable at its current levels. Revisions to the program should be made no later than mid-1999 so that the changes can be publicized and implemented by the start of the 1999-2000 rice season. The following should be done: · Reintroduce risk assessment while recognizing that a strong information campaign may be needed to distinguish future loan repayment obligations from the recent write-off of bad debt; · Eliminate top-down target-setting of amounts to be lent; · Reduce, if not eliminate, the KUT interest rate subsidy; · Maintain the current credit ceiling per farmer (Rp. 2 million) for 1999 but assess the need to revise the ceiling for the 1999-2000 crop; · Monitor the program intensely, and make monitoring independent of responsibility for reaching targets; · Give farmers the option of repaying directly to a servicing bank rather than through the KUD. Also needed is examination of the role of Bank Indonesia’s liquidity credit mechanism (KLBI). The new Bank Indonesia Law, which is about to be signed (June 1999), will phase out the provision of KLBI by Bank Indonesia over a six-month period. Bank Indonesia is expected to cease making new commitments to provide liquidity credits, with the credit support functions of KLBI being shifted to an alternative institution. Proposals for the development of commercially-based lending to small-scale rural borrowers need to be prepared for consideration by the incoming government. The following need to be taken into account: · The ability of commercial lenders to expand their business with smaller clients is constrained by the very high level of real interest rates, and careful macroeconomic management by the GOI to bring these rates down is critical. · A strong program is needed to build the capacity of smaller rural credit institutions to handle all aspects of financial management. Such capacity building and training could be done on a cost-sharing basis between government and the beneficiary institutions. Both Bank Indonesia and the Ministry of Cooperatives/Small Scale Business have training programs geared towards the smaller institutions, but the programs are quite small. Lessons on how best to develop capacity building programs can be drawn from BRI activities with TPSP, the 1980s Financial Institutions Development Project, and the Credit Union Coordination of Indonesia’s (CUCO) collaboration with the Canadian Co-operative Association. 29 · It is important to clarify the legal status of LDKP members that have not yet met the requirements for becoming BPR. The crisis has made the government reluctant to adhere to the 1997 deadline. A new deadline and requirements need to be established, and a determination made of the level of government support for the transition. · It is important to decide whether to revive the BAPPENAS program to promote expansion of the number of BKD, a program that died in 1992. Circumstances are now more favorable for assessing the feasibility and desirability of reviving that program. · Geographic limits on BPR activities need to be reviewed. Although the limits are not strictly enforced, their existence still hinders BPR’s efforts to reach clients in more remote areas. Eliminating them could improve credit access for rural inhabitants. · Timely use should be made of the survey of farm households conducted during the most recent rice harvest to compare the current situation with pre-crisis data from the same sample to assess farming profitability, cash flow, and working capital needs, and to integrate the findings into decisions on KUT credit policy. 31 Directions in Rural Credit Policy Policy Area Current Constraints Possible objectives Possible Policy Focus By mid-1999 By end-1999 After 1999 KUT Removal of banks’ responsibility Reintroduce risk assessment – Announce that implementing Begin implementation of the Continue implementation for risk assessment means that reinstitute executing status, but banks will return to executing return to an executing bank the KUT is vulnerable to recognize that a strong publicity status from current channeling program definition increasing non-performance in effort may be needed to status, beginning with KUT repayment distinguish the future from the mobilized for the 1999/2000 crop current environment Current KUT targets are related Eliminate top-down target setting Cease defining aggregate targets to GOI food crop intensification for amounts to be lent for the program objectives, not farmers’ demand for credit Current interest rate (10.5%) is Reduce, if not eliminate, the Prepare for and publicize a return Begin implementation Continue implementation highly subsidized and therefore is interest rate subsidy to near-commercial rates to begin a burden to the public budget and with KUT for the main creates incentives to divert 1999/2000 crop resources to higher interest- bearing time deposits than provided by farming loans Farmers who received KUT prior Maintain the credit ceiling per Maintain the credit ceiling as Implement the KUT ceilings, Ibid. to 12/98 got a credit package farmer (Rp. 2 million) as an currently defined and limit revised as necessary scaled to reflect subsidized annual ceiling of eligibility farmer eligibility for additional fertilizer, which is too small since through 1999 but permit farmers KUT cycles to verifiable cases of the fertilizer subsidy was lifted to upgrade to this ceiling once repayment of outstanding KUT; prior borrowings are repaid Evaluate whether revision of the KUT package amounts for the main 1999/2000 crop is needed because of anticipated inflation Monitoring of KUT repayment is Monitor the program intensely, Complete BI evaluation of KUT Initiate close monitoring and weakened now that banks are and establish clear responsibility in three provinces; clarify frequent reporting of repayment channeling rather than executing; for reaching channeling targets reporting obligations of of KUT coming due from the contracts with monitors have channeling banks 1998/99 scale-up expired prior to the main period of repayment KUT repayment by farmers and Allow farmers the option of Regulatory clarification to permit Monitoring of KUT repayment farmer groups via KUD have not repayment directly to a servicing KUT accounts into which farmer performance by repayment always resulted in debt Bank rather than through the groups can repay loans directly channel repayment at the managing bank KUD Other Bank Indonesia Too many schemes to be Reduce the number of schemes Announce intention to simplify Simplification initiated by Liquidity Credits (KLBI) managed effectively how this will take place merging, closing a major portion of the new schemes Rational for BI involvement in Revise enabling legislation for BI Parliament to pass a new law on Regulations to be drafted Implementation of the revised providing KLBI is unclear BI defining implementation of KLBI regulatory framework for KLBI 32 Policy Area Current Constraints Possible objectives Possible Policy Focus By mid-1999 By end-1999 After 1999 providing KLBI is unclear BI defining implementation of KLBI regulatory framework for KLBI as retained in the new BI Law Commercial Bank Credit – High nominal interest rates, weak Provide a macroeconomic See macroeconomic framework See macroeconomic framework See macroeconomic framework General financial sector, uncertain context within which commercial (IMF LOI and PRSL 2) (IMF LOI and PRSL 2) (IMF LOI and PRSL 2) political and economic context bank credit can prosper The credit policy framework Return as quickly as possible to Initiate an assessment of the Complete the assessment and GOI decision on the (PakJan 90) which had promotion the PakJan 90 framework success of the use of rural credit draft recommendations on the recommendations and start of of sustainable credit at its core is instruments for alleviating crisis phasing and sequencing of implementation suspended while the GOI uses social impacts compared with returning to PakJan 90 rural credit in an attempt to other instruments alleviate effects crisis Commercial Bank Credit – Ambiguous status of LDKP Transition of LDKP into BPR: Clarification by BI of intended Implementation initiated by BI Complete implementation of the Small-Scale plan and implementation actions and timeframe for LDKP of the defined action plan defined action plan which missed the 10/98 deadline for transforming into BPR Expansion of lending activity by Promote establishment of new Complete an assessment of the GOI review and decision on the Initiate implementation of the new BKD was blocked in 1992 BKD relevance of the original proposed next steps for next steps BAPPENAS plan to expand the expanding BKD number of BKD, with proposals for next steps Weak financial intermediation Establish collaboratively a longer Collaborative review (GOI, LSM, Completion of a draft strategic Action by GOI on the draft capacity of new LSM being term strategy for LSM graduation CIDES) of experience to date in framework for LSM graduation strategic framework brought into credit (KUT) to true financial intermediation channeling KUT; establishment to true financial intermediation activities of process to result in a strategy for GOI support and regulation of LSM activity in financial intermediation New opportunities for rural Strengthen public promotion of Clarification of government Rationalization and concentration Preparation of a reinforced public organizations to become involved training in financial agency responsibility for relevant of training and institutional sector program and draft budget in rural credit, either as providers intermediation and credit training, of the adequacy of capacity building by BI of formal for training and institution or borrowers, are not being management existing capacity and curricula, banking institutions, by Ministry building, to be included in the matched by capacity building in and resources needed for of Cooperatives for cooperative 2000/2001 budget these organizations to handle upgrading borrowers and cooperative credit effectively savings and loan units, and by xxx of informal banking entities 34 Annex 1 – Commercial Banks’ Outstanding Rupiah Credits (Total, Investment, Working Capital) by Group of Bank, Total and Agricultural Sector, in Rp. Billions Dec-96 Mar-97 May-97 Dec-97 Mar-98 May-98 Dec-98 OUTSTANDING CREDITS State Banks 93,051 93,977 97,795 113,436 133,572 134,516 160,113 o/w to Agriculture 11,734 11,973 12,206 13,178 13,640 13,653 16,413 Regional Government Banks 6,406 7,143 7,492 7,459 7,031 6,869 6,445 o/w to Agriculture 229 245 254 267 273 278 346 Private National Banks 123,788 132,283 137,085 128,016 131,539 132,452 132,710 o/w to Agriculture 3,110 3,837 3,998 6,803 8,767 10,680 12,551 Foreign and Joint Banks 11,245 11,557 11,586 12,623 14,783 14,309 13,850 o/w to Agriculture 85 103 95 92 149 136 120 Total 234,490 244,960 253,958 261,534 286,925 288,146 313,118 o/w to Agriculture 15,158 16,158 16,553 20,340 22,829 24,747 29,430 Agricultural Credit/Agricultural GDP 17% 20% 16% OUTSTANDING INVESTMENT CREDITS State Banks 33,712 34,896 41,957 43,891 55,202 o/w to Agriculture 9,929 9,949 11,214 11,007 11,731 Regional Government Banks 1,727 1,743 1,032 1,022 952 o/w to Agriculture 112 119 135 142 168 Private National Banks 17,352 18,391 14,834 14,196 16,588 o/w to Agriculture 1,203 1,226 1,513 1,589 1,529 Foreign and Joint Banks 1,366 1,351 2,617 2,513 2,131 o/w to Agriculture 25 24 39 39 15 Total 54,157 56,381 60,440 61,622 74,873 o/w to Agriculture 11,269 11,318 12,901 12,777 13,443 OUTSTANDING WORKING CAPITAL CREDITS State Banks 60,265 62,900 91,615 90,625 104,911 o/w to Agriculture 2,044 2,257 2,426 2,646 4,682 Regional Government Banks 5,416 5,749 5,999 5,847 5,493 o/w to Agriculture 133 135 138 136 178 Private National Banks 114,931 118,694 116,705 118,256 116,122 o/w to Agriculture 2,634 2,772 7,254 9,091 11,022 Foreign and Joint Banks 10,191 10,235 12,166 11,796 11,719 o/w to Agriculture 78 71 110 97 105 Total 190,803 197,578 226,485 226,524 238,245 o/w to Agriculture 4,889 5,235 9,928 11,970 15,987 CPI Index (1996 = 1.00 1.0391 1.0465 1.4215 1.5663 1.9864 Agricultural GDP 88,792 100,151 186,483 Source: Bank Indonesia Monthly Monetary Survey 35 Annex 2 – Commercial Banks’ Outstanding Rupiah Credits (Total, Investment, Working Capital), by Group of Bank, Total and to Agriculture, in Constant Rp. Billions (1996=100) Dec-96 Mar-97 May-97 Dec-97 Mar-98 May-98 Dec-98 OUTSTANDING CREDITS State Banks o/w to Agriculture 13% 12% 10% 10% 10% Regional Government Banks o/w to Agriculture 3% 3% 4% 4% 5% Private National Banks o/w to Agriculture 3% 3% 7% 8% 9% Foreign and Joint Banks o/w to Agriculture 1% 1% 1% 1% 1% Total o/w to Agriculture 7% 7% 8% 9% 9% OUTSTANDING INVESTMENT CREDITS State Banks o/w to Agriculture 29% 29% 27% 25% 21% Regional Government Banks o/w to Agriculture 6% 7% 13% 14% 18% Private National Banks o/w to Agriculture 7% 7% 10% 11% 9% Foreign and Joint Banks o/w to Agriculture 2% 2% 1% 2% 1% Total o/w to Agriculture 21% 20% 21% 21% 18% OUTSTANDING WORKING CAPITAL CREDITS State Banks o/w to Agriculture 3% 4% 3% 3% 4% Regional Government Banks o/w to Agriculture 2% 2% 2% 2% 3% Private National Banks o/w to Agriculture 2% 2% 6% 8% 9% Foreign and Joint Banks o/w to Agriculture 1% 1% 1% 1% 1% Total o/w to Agriculture 3% 3% 4% 5% 7% Source: Bank Indonesia Monthly Monetary Survey 36 Annex 3 – Agriculture Sector Share of Total Outstanding Rupiah Credits of Commercial Banks, by Group of Bank Dec-96 Mar-97 May-97 Dec-97 Mar-98 May-98 Dec-98 OUTSTANDING CREDITS State Banks o/w to Agriculture 13% 12% 10% 10% 10% Regional Government Banks o/w to Agriculture 3% 3% 4% 4% 5% Private National Banks o/w to Agriculture 3% 3% 7% 8% 9% Foreign and Joint Banks o/w to Agriculture 1% 1% 1% 1% 1% Total o/w to Agriculture 7% 7% 8% 9% 9% OUTSTANDING INVESTMENT CREDITS State Banks o/w to Agriculture 29% 29% 27% 25% 21% Regional Government Banks o/w to Agriculture 6% 7% 13% 14% 18% Private National Banks o/w to Agriculture 7% 7% 10% 11% 9% Foreign and Joint Banks o/w to Agriculture 2% 2% 1% 2% 1% Total o/w to Agriculture 21% 20% 21% 21% 18% OUTSTANDING WORKING CAPITAL CREDITS State Banks o/w to Agriculture 3% 4% 3% 3% 4% Regional Government Banks o/w to Agriculture 2% 2% 2% 2% 3% Private National Banks o/w to Agriculture 2% 2% 6% 8% 9% Foreign and Joint Banks o/w to Agriculture 1% 1% 1% 1% 1% Total o/w to Agriculture 3% 3% 4% 5% 7% Source: Bank Indonesia Monthly Monetary Survey 37 IV. AGRICULTURAL COOPERATIVES IN INDONESIA Introduction In spite of the historical popularity of cooperatives in The Netherlands (Braverman et al. 1991), cooperatives did not play much of a role in the agriculture of the Dutch East Indies. They did not spring up in Indonesia until the post-World War II Sukarno era, when they developed a distinct Indonesian form. We begin by reviewing the nature of cooperatives generally, and of their Indonesian variants. The recent decades are of greatest relevance for this discussion, and that part of Indonesian history is charted. The implications of recent changes in Indonesia are then explored from the perspective of contemporary global experience with cooperatives Principles of the Cooperative Movement Different authorities have articulated preferred sets of cooperative principles, such as Abrahamsen’s (1976) version of the “Rochdale principles”: (a) member control; (b) limited returns on member equity; (c) business operations at cost (sharing savings/benefits of the cooperative in direct proportion to each member’s patronage, such as gross sales or purchases); (d) member ownership; and (e) duty to educate. How these various principles are applied in practice has varied greatly around the world. Some of these generic issues are discussed briefly by way of setting the context for examining the Indonesia experience. Strengths and Weaknesses of Cooperatives A cooperative is jointly owned by its members, for their own collective purposes and self-help. In most cases where there is substantial business activity, the membership hires a manager to run the cooperative, and report regularly on progress. Ideally, there is a high degree of transparency in operations, with clear accountability to members. If the cooperative trades profitably and the benefits are returned to members according to their rightful shares, members have a clear signal as to the degree of support they should give to the cooperative. Managers, in turn, are given an incentive to manage the resources under their control by the conditions of their appointment by the cooperative. In this environment a pure cooperative will function efficiently and responsibly. In the real world, however, things work differently. If governments intrude into the affairs of cooperatives, signals become blurred. If managers are government appointees who owe allegiance primarily to the government rather than to members of the cooperative, the scene is set for misdirected accountability. If cooperatives, in turn, are used as quasi- government agencies with loose budget constraints and a ready claim on public resources, the 38 incentives for efficient management become perverse. If the management of a cooperative uses the organization as a vehicle for personal gain and access to opportunity for corrupt practice, it will surely not be being responsible to the membership. Whether such a “cooperative” succeeds as an arm of government will depend on the quality of management, but it will not be a cooperative in the classical sense of the word. The “cooperatives” of Indonesia have functioned largely in such non-“cooperative” modes. Roles for Government This raises the question of the proper role of government in cooperative development. The proper role is doubtless a highly constrained one. The government should, of course, enact legislation that permits the creation of cooperatives as legally constituted bodies. Crafting regulations (including those relating to taxation) to permit cooperatives to operate effectively is also a necessary role for government. Ensuring that the legal environment is able to enforce regulations relating to cooperatives is a more general task of government. But it is difficult to see any additional involvement by government that is needed or defensible. Recent Institutional Developments The classical principles of cooperatives now appear rather dated, given the variety of cooperative forms that now exist, and which function along side NGOs and not-for-profit voluntary organizations in rural development. But “new” roles such as improved natural resource management (especially where resources are held in common or subject to shared threats), can also fall into the domain of purposeful associations like cooperatives. Specifically, these could include cooperatives formed to address in part what Randall (1999) calls “the isolation paradox”-- where individual action fails but where everyone would be better off with coordinated action than no action at all. A recent study by the OECD (1998) presents one interesting synthesis of experience in industrial countries regarding of natural resources. Programs such as those of the “Landcare” groups in Oceania provide good material on how cooperative ideals and organizational forms can be brought to bear on “business” that is hardly of the conventional type. The types of actions that come under voluntary group control range from land-use practices such as clearing and stocking rates, to mutual investment in land improvement structures. It is perhaps too early to form definitive judgments about such unconventional cooperative endeavors, but early experience is generally encouraging (see, e.g., Anderson and Rifianto 1999). Cooperatives In Indonesia The early objective of cooperatives in Indonesia was providing loans to help small-scale farmers, but the development of those cooperatives was not fully successful. 12 Most of those early cooperatives grew slowly. 12 This section draws heavily on Soetrisno (1992) and personal reflections of Sularso (with assistance of Soebroto Hadisoegondo) in his background paper for this Mission. 39 During the 1950s there was greater opportunity to establish cooperatives according to member’s specific needs, sometimes as those of producers of specific commodities (sugar cane, tobacco, rubber, copra) or as general-purpose rural and agricultural cooperatives. Some Indonesian cooperatives established their own secondary-level cooperatives, and beyond that, in some cases an apex organization. The cooperatives’ several organizational layers were used as an instrument for supporting national revolution, as illustrated by the prevalence of political representatives on cooperatives’ boards of directors. This was not only legalized but strongly encouraged by the promulgation of Cooperative Law No. 14 (1965). The outcome was that cooperatives succeeded only as vehicles for rent-seeking, and most suffered greatly or failed during the economic difficulties of the 1960s. In line with the birth of the “New Order”, cooperatives also began a process of rehabilitation that started with enactment of Cooperative Law No. 12 (1967). The law had the stated intention of eliminating political interference and getting “back to basics”, and thus was supposed to foster the development of genuine cooperatives (Barton 1989). All members of a cooperative were expected to be active participants. In 1970 the government introduced the village-level cooperative (KUD) concept. Rural cooperatives were integrated into larger groups to make them stronger. In fact, there were opportunities to implement additional viable activities, which increased rice production significantly. The bigger the area exploited, the better the program for increasing rice production was argued to be. Cooperative functioning focused on making loans to rice farmers (through KUT finance), distributing fertilizer and other production inputs, and procuring rice for national stocks13. Operation and Efficiency of KUDs The main activities assigned to KUDs involved implementation of government rice intensification programs and attending to members’ supposed agribusiness desires (such as marketing cloves), and providing capital at low interest rates. The latter naturally involved local monopolies and often heavy subsidies. Government held the view that it was ensuring that cooperatives could take over these tasks and have a secure place in the market. These were taken to be legitimate roles for government. Government officials felt entitled, if not obliged, to help cooperatives in this way and thus to protect the flow of government subsidies and the provision of facilities, as well as sustain the politicized KUD organizations. During the 1960s, many KUDs received assistance from foreign sources to put into place what continue to be their main assets, such as drying floors, small rice mills, storage sheds, and grain dryers. Although some KUDs were able to position themselves as profitable 13 BULOG’s rice procurement program is a major wedge that separates KUD members from the managers of the cooperatives. Typically, KUD managers sell their “delivery orders” for BULOG rice to local private traders. They make their money not by buying rice for public procurement but by living off the rents of the rice-delivery order. 40 business entities, many others lacked managerial capability. Without clear incentives for good management, corruption occurred, thereby compromising the efficiency of the KUDs. In 1973 presidential instruction (Inpres) No. 4 defined KUDs as multipurpose agricultural cooperatives. The government then introduced a new type of credit scheme for the smallest rural groups, a scheme called Kredit Candak Kulak (KCK, or very small credit for the rural trader), which was to be administered through the KUDs. The next relevant Inpres was issued in 1978, and emphasized the activities of multipurpose cooperatives. In 1984, Inpres No. 4 consolidated the KUDs. Agricultural commodity and input cooperatives had to merge into the KUD structure, and no other cooperative form was allowed. This was yet another form of pervasive government interference designed to control rural people’s initiative and aspirations. The freedom of rural citizens to express their own views on cooperatives, was blocked for over 14 years. But farmers who were obliged to pay mandatory fees to KUDs for years while not receiving valued services, did not become a constituency supportive of KUD continuance. It was eventually realized by government that this policy was not effective. Meanwhile, demands that rural business functions should be performed in a more effective manner grew. To respond to these perceptions, a law was passed in 1992 that was intended to transform cooperatives into autonomous business entities and to eliminate government interference in their activities as much as possible. Members of cooperatives were to have clear responsibility to make the most of the opportunities of their cooperative structures and to face up to the task of developing them themselves. But the 1992 law was neither publicized nor implemented. Key architects of the reforms shifted to other ministries after being frustrated in efforts to implement the reforms. Current Directions All concerned had to wait until 1998 to see a new emphasis on cooperatives as private business entities operating in a free market. The new law gives cooperatives a full opportunity to become real cooperative entities. Inpres No. 18 makes it clear that KUDs will not be the only cooperatives in rural areas and explicitly broadens the possibilities of establishing joint programs among cooperatives, and between cooperatives and private-sector entities. Within the past few months, many new consumers’ cooperatives have emerged, largely in urban areas. Government facilities now offer a new distribution channel for key commodities. One of these is the new arrangement for distributing cooking oil, although it is not obvious that this was a commodity for which there really was such a need, given the network of largely ethnic-Chinese traders that existed. However, the reality is that the KUDs are still “working” within government rules, such as distributing KUT credit (credit for farmers’ rice production) and continuing their activities in rice procurement, through management of Kredit Kepada Koperasi (KKOP, credit for rice procurement). So, in spite of new legislative developments, most of the KUDs have yet to 41 reform themselves. Worthy change could take several forms. Greater democratization could be achieved by giving cooperative members genuine freedom to associate with other members and to become active in cooperative activities. The process will in many cases be a long-term one, requiring considerable investment in educational effort. Progress may also be made by implementing a process of amalgamation to establish cooperatives that are more viable in economic terms. In some cases, this may involve developing more specialized cooperatives by taking a commodity approach and developing competence in focused agribusiness sectors. Clearly, however, there will be a tradeoff between efficiencies gained through increased size and the “distance” between management and members (Lehman and Parliament 1991). Recognition of the need for reform of KUDs led to a major study by the Japan Cooperatives Agency (1998). This report (in English in two volumes) describes five years of intensive work by a large team working at national, provincial, and district levels. Detailed analyses and suggestions are made for changing many aspects of both the organization and management of KUDs (including training arrangements). For some reason (perhaps a lack of farmer support for KUD sustenance), the report seems to have attracted little attention from either the government or the NGO sector. There are two main currents in the current debate on policy. One is the “People Economy” movement (see Soedjono 1999) that seeks the economic empowerment of the poorest groups in Indonesian society through various cooperative efforts. The other is the rise of enthusiasm for private initiatives, variously alluded to as “agribusiness development” by the Ministry of Agriculture and “small and medium enterprise development” by the Ministry of Cooperatives, Small and Medium Enterprises. Thus, there appears to be a tension developing between these two government departments and perhaps between other forces shaping the future of cooperatives and alternative business entities serving the rural sector.14 Recent Bank work is providing implicit support for the small enterprise route (se, e.g., OED 1998), although the Bank’s dominant approach now seems to be decentralization in one form or another (Manor 1999). At the beginning of 1999 there were 7,123 KUDs (with some 10 million members), and 37,584 non-KUDs (some 12 million members in true farmer groups [kelompok tani] that some regard as proto-cooperatives rather than true cooperatives). KUDs have declined progressively in numbers in recent years while non-KUDs have fluctuated but trended upwards (Pusat Data Informasi, Departmen Koperasi). It is said by concerned departmental staff that the rate of increase in non-KUDs this year has been high. Thus the policy may be to “let many flowers bloom”. Provided that managerial and financial responsibilities are acceptably handled, that is how things should be. But as the following section suggests that may not be the case. Rural Credit Issues As part of its crisis management program, the government has launched a seventeen- fold increase in programmed credits to provide credit alternatives perceived to be needed by the 14 The planned ratification of a reunited national apex organization for cooperatives¾the Indonesian Cooperative Council, DEKOPIN¾has gone more slowly that expected and may not occur until after the election in June. 42 people to help meet their basic needs. Those credits are nominally set up according to the demand and characteristics of each set of activities. In this case, the KUDs have an opportunity to help their members. There are at least three types of credit -- KUT, KKPA and KKOP -- that are designed to help farmers fund their activities, starting from the beginning of an activity through to the end of the production cycle and also for post harvest work. However, some secondary cooperatives still have an unfilled need for credit -- for example, those concerned with dairy and palm oil processing. Although there are several types of agricultural credit available to farmers, some of the most important (particularly KUT), are still implemented through a top-down approach. This has generally been counter productive because it has lessened responsibility on the farmers’ side. Past KUT programs still have large numbers of bad debts, and it is likely that there will be many more nonperforming loans in the near future. Thoughtful Indonesian observers argue that a proper implementation policy would develop indigenous capabilities among farmers, who should take responsibility for both capital formation and for lending decisions. Meantime, cooperatives are being invited to help distribute microcredit and to tell farmers to make loan requests based on their ability to repay prospective loans. Credit unions and group- development projects in cooperation with Rabobank Foundation and Bukopin/KPI (the Cooperative Finance Corporation) could be one model for further cooperative-linked development of agricultural credit. Conclusion For much of recent times, cooperatives in Indonesia have served as the primary vehicles for implementation of the agricultural intensification programs of the government. The sector faces many difficulties of both immediate and long-term concern. The system of some 7,000 mostly multi-purpose KUDs is not performing even its few major operative roles well (mainly rice procurement and fertilizer distribution), and the limited membership and coverage, and the top-down governance, severely confine the scope of activities of a broader development nature. The new freedoms for cooperative formation launched in 1998 provide a vehicle for more focused associative activities by farmers and others, but the experience with the largely discredited KUDs has dampened enthusiasm for such innovatory group endeavor. Nonetheless, the 1998 change was a policy move in the right direction. Further progress in cooperative reform will be difficult until a new administration settles in following the June 7 election and the subsequent process of naming a president. Meantime, the following would be useful steps. Most amount to “getting back to basics”, with the government taking a broad market-augmenting role. (a) Continue to encourage the democratizing of KUD governance by (i) sending clear signals from all branches of government concerned, especially the Department of Cooperatives, and (ii) once governance has been reformed, cautiously assessing training assistance needs,15 to improve management (what Timmer [1991] sees as a key source 15 The case for government involvement in training is less than clear, since cooperatives in principle should be able to make their own arrangements. In the past this sort of activity has been helped by the Cooperatives Education Agency but that is now uncertain following the announcement in late April 1999 that the Cooperative Center of Denmark (CCD) was to withdraw its funding for the Agency. CCD and the 43 of failure). The latter will necessarily involve some detailed assessment work to determine the availability of qualified managers, to articulate a policy for retiring less than fully professional managers, and to clarify which are the most needy sectors, and thus how best to allocate the already considerable training resources. Training-type activities might also extend to providing information on non-traditional roles for cooperatives, such protecting natural resources. (b) Ensure that the elimination of monopoly privileges is sustained. There will doubtless be pressures to intervene when it is perceived that in specific instances the private sector is not yet able to function adequately to provide a genuine alternative, but these must be resisted, apart from allowing KUDs and others to become efficient providers of such services. Cooperatives of inadequate managerial capacity and poor performance do their members no good, and thus efforts must be made to ensure that any continuing access to government programs is restricted to cooperatives that meet stringent capacity and performance criteria. The practice of bailing out nonperforming cooperatives must be abandoned. (c) Some, if not many, KUDs and other cooperatives are bound to fail (especially if subjected to such test), but the disposition of residual (in most cases, quite small) assets should be left to members and the local community to sort out. (d) After the present crisis ends, any need for preferential access to subsidized credit by the cooperative sector must be carefully reassessed. Meantime, monitoring and evaluation of the KUT lending program should be actively pursued so that there is a relevant database with which to begin a general re-assessment. V. FERTILIZER Indonesia has developed a technically sophisticated, state-owned, highly regulated, and heavily subsidized fertilizer subsector to contribute to the national objectives of rice self- sufficiency and increased non-oil export income through value-added exports of urea fertilizer from indigenous natural gas. Rice self-sufficiency was achieved in the mid-1980s and more or less maintained for a decade. Total domestic fertilizer consumption reached 5.8 million product tons in 1995, an increase of about 127 percent since 1980. Consumption declined slightly in 1996. A combination of factors in 1997 and 1998 created a crisis in the fertilizer sector and a need for an increase in rice imports. These factors included drought and extensive fires in 1997, early rains in 1998, a national and regional economic crisis, the ill-advised establishment of a two-tier domestic urea pricing system in 1997, and production problems at P. T. Petrokimia Gresik (PKG), one of the six government corporations in Indonesia that produce chemical Canada Cooperative Association were planning to withdraw their financial and technical support of the Indonesian Cooperatives Council (Dekopin) in protest of the appointment of “a controversial businessman” as its new chairman. 44 fertilizer. As a result, domestic fertilizer consumption fell by almost 20 percent in 1997 and fertilizer subsidies for the food crop sector were reintroduced. In 1998 the fertilizer subsidy escalated out of control because of leakage of subsidized product from the subsidized food crop sector to the unsubsidized plantation sector, and into illegal exports. Spot shortages of urea, phosphate, and potash occurred in the domestic fertilizer market, and substantial quantities of rice imports were required in both years. Fertilizer Consumption The evolution of domestic fertilizer demand is shown in Table 1. Approximately 76 percent of domestic fertilizer use occurred in the food crop sector from 1991 to 1997 (see Table 2). Java accounts for about 75 percent of urea use, 64 percent of superphosphate 36 use, and about 75 percent of potash use. Urea use on paddy, particularly in Java, has averaged about 95 percent of recommended rates, or 250 kg per ha, and rates of 300 kg per ha have not been uncommon. Such excess urea use above recommended rates was induced by the highly subsidized price. On the outer islands, urea use on paddy is about 30 percent below recommended rates; phosphate and potash use are almost nonexistent. Promotion of balanced fertilizer use by the GOI led to a sharp increase in potash use during the 1990s, but that was insufficient to maintain stability in fertilizer nutrient ratios, with phosphate and potash use declining in relation to nitrogen (see Table 3). In addition to production for the domestic fertilizer market, urea is produced for industrial use, mainly manufacture of adhesives for the plywood industry. This market has been growing at an annual rate of just under 8 percent since 1990, and production totaled 478,665 mt in 1998. Surplus urea is exported. The annual quantity of exports has varied from 1 million mt in 1987 to 2.36 million mt in 1997 (see Table 4). Fertilizer Production The domestic fertilizer industry is composed of six major government corporations with one Apex (holding) corporation: (1) P. T. Pupuk Sriwidjaja – PUSRI (Palembang, S. Sumatra) (2) P. T. Petrokimia Gresik - PKG (Surabaya, E. Java) (3) P. T. Pupuk Kalimantan Timur – KALTIM ( Bontang, E. Kalimantan) (4) P. T. Pupuk Iskandar Muda – PIM (Lhok Seumawe, N. Sumatra) (5) P. T. Pupuk Kujang - KUJANG (Cikampek, W. Java) and (6) P. T. Asean Aceh Fertilizer – AAF (Lhok Seumawe, N. Sumatra). 45 Table 1: Indonesia - Domestic Fertilizer Consumption, 1975-1998 Year Urea AS TSP/SP3 KCl Total 6 ('000 Product Tons) 1975 676 94 235 34 1039 1980 1776 330 494 123 2723 1985 2607 475 1048 290 4420 1990 2983 605 1261 510 5359 1991 3097 606 1256 444 5403 1992 3410 608 1290 482 5790 1993 3095 639 1173 366 5273 1994 3288 615 1125 302 5330 1995 3710 653 1070 404 5837 1996 3918 588 900 375 5781 1997 3324 351 663 350 4688 1998 4290 408 869 330 5897 Growth Rate Per Annum % 1975/80 21.30% 28.50% 16.00% 28.55% 21.25% 1980/85 8.00% 7.56% 16.23% 18.71% 10.17% 1985/90 2.70% 4.96% 3.77% 11.95% 3.93% 1990/95 4.60% 1.54% -3.23% -4.55% 1.72% 1995/98 4.96% -14.51% -6.70% -6.53% 0.34% 1990/98 4.60% -4.81% -4.55% -5.30% 1.20% The first five are domestic operations, while AAF is a joint venture company with ASEAN member governments, 60 percent owned by the GOI and limited to export trade to ASEAN member countries. The companies produce ammonia and urea at eleven plants. Of these, only the three plants constructed in the 1990s for PUSRI, PKG, and KALTIM have world-standard energy efficiency (under 30 MM Btu/Mat ammonia). The older plants were optimized for energy efficiency and increased capacity in the early 1990s. As a result of these improvements, along with a location advantage and relatively low natural gas prices, Indonesian urea production costs are internationally competitive for Southeast Asian markets. Actual production costs are estimated to vary from between US$61 and $65/mt. PKG also produces superphosphate 36, ammonium sulfate (AZ), and cement in an integrated production process. Superphosphate 36 replaced triple superphosphate production in 1994. In addition KALTIM, PUSRI, and PIM produce hydrocarbon-based chemicals. Plant capacities and production data are presented in Table 5. 46 Each of the five wholly owned production companies is a state-owned limited liability company. The Department of Basic Chemical Industries within the Ministry of Industry and Trade (MOIT) is responsible for the development of the fertilizer industry, including planning, feasibility studies, and compilation of production data. The Ministry of Finance (MOF) has the authority to finance imports as well as prepare budget outlays for fertilizer subsidy. The MOIT is responsible for import licenses and the registration of importers, wholesalers, and retailers of fertilizers. Table 2: Indonesia - Fertilizer Use on Food Crop Sector Only, 1991-1997 Year Urea AS TSP/SP3 KCl Total 6 ('000 Product Tons) 1991 2577 487 1006 178 4248 1992 2820 507 1019 175 4521 1993 2476 511 887 117 3991 1994 2544 493 812 65 3914 1995 2917 531 844 76 4368 1996 3126 470 757 61 4414 1997 2719 299 523 42 3583 Growth Rate per Annum % 1991/95 3.15% 2.19% -4.29% -19.17% 0.70% 1995/97 -3.45% -24.96% -21.28% -25.66% -9.43% Source: APPI 1999 In 1997, all of the government’s shares in each company were transferred to PUSRI, which became the holding company for the industry. This move was carried out to pool financial resources, optimize maintenance operations, pool training resources, and coordinate marketing operations. Fertilizer Distribution PUSRI has become responsible for the distribution of all subsidized domestic fertilizers from the other production factories to ports and regional warehouses. Marketing staffs are situated in Palembang and in all regions for this purpose. Distribution includes operation of six bulk urea ships and one leased ship to carry bulk urea to bagging plants. The Ministry of Cooperatives (MOC) monitors and supervises all KUDs, which have been the main outlets allowed to distribute fertilizers for the food crop sector to local cooperative retailers. Distribution of fertilizer to the estate crop sector has been in the hands of private sector distributors/retailers. Poor performance by the KUDs led to increased supervision of their retail activities by PUSRI marketing staff in the mid-1990s. The KUD system was 47 instrumental in providing KUT-subsidized credit to food crop farmers, based on recommended levels of inputs. Approximately 25 percent of fertilizers in the food crop sector were bought on formal credit, the remainder for cash or informal credit. Fertilizer Prices and Subsidies Retail fertilizer prices were, until recently, controlled pan-territorially through a complex freight equalization scheme administered by PUSRI. This was a cost plus system, with an allowed Rp 1, 000/mt profit margin. Deducting distribution and retail margin costs from the retail price provided an average procurement price at each factory (the HP price), which was paid by PUSRI to the Bank of Indonesia. Retail prices were set in relation to the minimum procurement price for paddy to provide a urea-to-paddy price ratio between 1.3:1 and 1.4:1 (see Table 3). Production prices were based on prior year production costs plus Rp. 5,000/mt profit margin (HPP) and were paid to each company by the Bank of Indonesia. The difference between HPP and HP prices represented a direct subsidy to the companies paid by the MOF to the Bank of Indonesia. Most of the fertilizer subsidies in the early 1990s were for differences between the HPP and HP prices for phosphates, ammonium sulfate and imported potash. The prices paid for urea tended to be less than the export value, and the companies made additional profits from export sales. For equity purposes, each company was provided with an export allocation. The system for urea was largely left in place, but farm level prices in 1996 for other products were decontrolled, allowing the full costs of production and distribution to be reflected in retail prices, including the retail price for urea sold to the estate crop sector. In 1997, because of rapid devaluation, price controls and subsidies were re-established for the food crop sector (see Table 4). These included exchange rate subsidies for imported potash and rock phosphate. In addition, fertilizer production remains directly subsidized through the natural gas pricing system and implicitly subsidized through exemption of primary inputs from the 10 percent value added tax (VAT). Natural gas contracts between the fertilizer companies and Pertamina vary from $1/MM Btu to $2/MM Btu, including a 1 percent royalty fee to Pertamina. However, up until December 1998 the GOI had Pertamina to charge no more than $1.50/MM Btu and paid a $0.50/MM Btu subsidy to Pertamina. Recent Policy Responses Changes in policy for the fertilizer subsector include: · removal of farm input subsidies and fertilizer production subsidies, including the natural gas subsidy; · a partial adjustment to border parity pricing through partial market liberalization; · changes in retailing and credit for cooperatives in the food crop sector; · increased minimum inventory levels in the distribution system; · elimination of the two-tier pricing system for urea; 48 · reductions in interest rates along with increased credit allocations for farmers, and increased floor prices for rice; · transport subsidies for fertilizers distributed to farmers in remote areas. Table 3: Indonesia – Ratio of Floor Price of Paddy and Ceiling Price of Urea, 1984-1998 Year Paddy Urea Ratio Rp/kg Rp./kg 1984-86 70 100 0.70 1987-88 190 135 1.41 1989-90 250 185 1.35 1991-92 295 220 1.34 1992-93 330 240 1.38 1993-94 340 260 1.31 1994-95 360 260 1.38 1995-96 400 260 1.54 1996-97 450 330 1.36 1997-98 525 400 1.31 1998-99 1115 1400 0.80 These changes are expected to be fiscally neutral, but the increased floor price for rice combined with increased rice allocations for the very poor could create an additional budgetary burden. Under a decree of the Minister of Industry and Trade in January 1999, the following changes were specified: · PUSRI was assigned responsibility for the supply and distribution as well as the availability of fertilizer (urea, SP-36, ZA, and KCl) for food crop farmers in remote areas. PUSRI was ordered to give priority to cooperatives and small-scale businesses in the distribution of urea. · Identification of remote areas and the amounts of fertilizer required for each area were assigned to the Ministry of Agriculture. 49 Table 4: Indonesia - Maximum Retail Fertilizer Prices, 1987- 1998 Year Urea AS TSP SP36 KCl Exchange Rate Rp. Per kg Rp./US$ 1987/88 135 135 135 135 1,640 1988/89 165 165 170 170 1,690 1989/90 185 185 210 210 1,750 1990/91 210 210 260 260 1,890 1991/92 220 220 280 280 1,950 1992/93 240 240 310 350 2,058 1993/94 260 260 310 350 2,122 1994/95 260 295 480 420 fm 2,199 1995/96 330 355 525 420 fm 2,296 1996/97 330 355 648 525 fn 2,370 1997/98 400 450 648 600 fm 6,680 Oct-98 450 506 fm 675 850 7,750 Dec-98 1,115 1,000 fm 1,600 1,650 8,000 Source: Ministry of Finance 1999 Note: fm = Free market The MOF reported the total financial cost of fertilizer subsidies in 1997-98 at Rp 2,257 billion (US$282 million at an exchange rate of Rp 8,000), as shown below: Subsidy Element Billion Rp Million US$ % of Total Subsidy Direct gas* 703 87.9 31.1 HHP-HP price difference 644 80.5 28.5 Handling fees 9 1.1 0.4 VAT 198 24.8 8.8 Exchange rate 703 87.9 31.1 TOTAL 2,257 282.2 100.0 * Does not include Pertamina income forgone on natural gas contracts or income forgone from opportunity price of gas in alternative domestic markets. These changes were made because the high cost of servicing remote areas is an obstacle to private sector participation. The changes in domestic trade of fertilizer were designed to eliminate PUSRI’s monopoly on distribution. 50 Further Adjustments Planned Further adjustments in administrative pricing are planned. The pan-territorial prices are to be changed to reflect actual distribution costs in Java, Bali, Sumatra, and West Kalimantan, except for remote areas, where a transport subsidy will continue. In addition, food crop farmers in remote island areas will receive a fertilizer transport subsidy. Prices are to be adjusted quarterly to equate with border prices and to reflect exchange rate movements and increases in inflation. Natural gas pricing policy is also being reviewed. Underlying these policy changes is a planned privatization of the fertilizer production companies, with KALTIM and PUSRI targeted as the first to be privatized. The Case for Market Reform The development of domestic fertilizer production was instrumental in achieving rice self-sufficiency, but the cost was extremely high. In the early 1990s, the direct budget subsidy for fertilizer amounted to 40 percent of the agriculture and irrigation development budget. Partial and uneven reduction of the subsidy in the mid-1990s, however, has been a major cause of nutrient imbalance. The re-introduction of subsidies, followed by their abrupt removal because of the crisis, created a shock that has been tempered by overly generous subsidized credit schemes for small farmers. The state-owned distribution system continues to be inefficient in both cost and resource allocation, thus creating distortions in cropping patterns, land, and fertilizer use. The increase in fertilizer prices caused by the removal of subsidies needs to be offset by savings in distribution and marketing costs that can only be achieved through competitive marketing. The use of KUD cooperatives as the only retail channel for fertilizer inputs to the food crop sector has been detrimental to the interests of small farmers. Lack of competition has led to poor service and poor management. Market reform would eliminate the high costs of parastatal distribution operations and improve allocative efficiency. In the medium term, it would provide increased product and technical services to small farmers, result in higher yields and higher rural wages, more sustainable use of natural resources (by reducing the encroachment of farms onto fragile ecosystems), and higher farm incomes. Competitive markets educate consumers, who then become more demanding as the consumer recognizes that various services may be offered and forcing sellers to respond by improving services and increasing efficiency. This paper recommends the establishment of marketing networks by private companies that would each sell their own product in competition with each other and with other private sector importers and distributors. Transport economics would cause competition between the companies to be limited to areas where the marketing networks come into contact with each other. The Case For Privatization The overall objectives of privatization are seen as (i) achieving a sustainable supply of fertilizer in Indonesia, (ii) making fertilizer production more efficient, (iii) attracting private 51 financing, (iv) implementing a rational program of investment in the sector, and (v) generating income for the government. Although Indonesia’s fertilizer producers are experienced companies, operating efficiency lags behind that achieved by best practices by about 5 percent. Phosphate and ammonium sulfate continue to be relatively costly by international standards. There is no longer any rationale for the GOI to consider urea fertilizer as a strategic commodity. The entire agricultural sector would benefit if the fertilizer production companies were compelled to achieve a sound commercial footing without any GOI involvement other than regulation to safeguard consumer interests. Policy Reform Issues The policy reforms of December 1998 provide the groundwork for a transition from a heavily subsidized and administered fertilizer sector to an unsubsidized private system. Prospects are good for meeting the government’s twin objectives of providing Indonesian farmers with adequate supplies of internationally competitive priced fertilizers and establishing internationally competitive private production companies. The issues that need to be resolved are: (a) how to ensure market-based pricing and competition; and (b) how to optimize the asset value of the companies. There is a need for: · A clear policy framework for the fertilizer sector · A transparent policy on fertilizer imports · A rationalization of long-term policy on natural gas pricing · Increased competition in domestic fertilizer distribution and marketing · Production company restructuring to optimize asset value · Restructuring of PUSRI’s distribution mechanism · Establishment of a regulatory system to safeguard the interests of fertilizer purchasers · Improved collection and dissemination of market information, particularly on retail prices. Immediate privatization of the production companies is out of the question, of course, because of uncertainty about these issues, the depressed international fertilizer market, and potential investors’ perceptions of high risk. A Strategic Policy Reform Program The elimination of fertilizer subsidies in December 1998 was illusionary. The subsidies were simply transferred from the fertilizer sector to the rural credit sector. Fertilizer prices are still administered, and the monopoly on fertilizer distribution survives due to an uneven playing field vis a vis the private sector--especially the relative costs of capital. Recent importation of fertilizers by private sector firms has been under the direction of public sector entities. It can be said, though, that the government’s 1998 decision paved the way for further reform. 52 The Major Issues Urea Fertilizer Pricing. The strategic objective is to achieve border parity with international prices so that producers have no incentive to favor domestic over international sales, or vice versa. Java, which accounts for almost 75 percent of domestic urea use, is a net importer of urea. Border prices in Java therefore should be set at c.i.f. values. Sumatra and Kalimantan, on the other hand, are net exporters of urea, and border prices should be set at f.o.b. values. Current f.o.b. values are about $94/mt, current c.i.f. values about $104/mt bulk. This spread has been consistent over time. F.o.b. values are location and port dependent; KALTIM and PIM have export loading capacity and location advantages over PUSRI for export sales. C.i.f. values in Java (and elsewhere) are elevated by restrictions on cargo sizes caused by limited port facilities. That should provide a freight advantage to domestic “imports” from KALTIM and PUSRI. PUSRI has little comparative advantage in international export markets, while KALTIM has capacity in excess of current regional export requirements. In a deregulated market, both companies would continue to be dependent on supplying urea to West and East Java, respectively, at minimum prices equivalent to ex-factory f.o.b. plus freight (“domestic c.i.f.”) and maximum prices equivalent to international c.i.f. prices. In order for PKG and KUJANG to sell their urea production in Java, both companies will have to set ex- factory prices equivalent to or slightly below c.i.f. border prices. This will have the advantage of raising revenues from the sale of urea for both companies compared to the current administered prices. The price of PKG’s ammonium sulfate (AZ) will be determined by its nutrient value relative to urea in markets subject to the import parity maximum. Pricing Other Fertilizers. Indonesia is a net importer of all other fertilizers and fertilizer raw materials, except for sulfuric acid. Domestic ex-factory prices should be set at border parity with c.i.f. prices. Currently, phosphate fertilizer ex-factory prices are slightly below c.i.f. parity, allowing for parity at distant locations. Pan-Territorial Pricing. PUSRI said that pan-territorial pricing would be abandoned on April 1, 1999. The existing system penalizes farmers close to the source of supply and subsidizes those furthest away. Misallocation of resources and farming system distortion occur as a result. The system is also administratively burdensome. However, small markets in the outlying islands incur excessive distribution costs because bagged product must be sent in small loads over considerable distances. Freight subsidies have been proposed because rice production by migrant farmers in many remote locations has been encouraged, and unsubsidized freight costs significantly alter the economics of fertilizer use, to the detriment of food crop production. In a deregulated system, however, transport subsidies would be difficult to administer and be subject to leakage. Better targeting of the subsidy to small farmers could be achieved through a fertilizer voucher system. Product leakage to other markets would be negligible because the vouchers could only be redeemed in remote locations. Fertilizer Prices, Use Efficiency, and Demand. The administered prices of fertilizers are shown in Table 4. The farm gate price for urea increased by 248 percent, from Rp. 450,000/mt in October 1998 to Rp.1,115,000/mt in December 1998. The export border parity price, based on f.o.b. export price of US$94/mt bulk (Indonesia is a net urea exporter) is 53 estimated at US$105/mt bagged at regional warehouses. This compares favorably with the current price of US$100/mt (Rp. 900, 000). The Paddy:urea price ratio, based on the minimum procurement price of paddy and the maximum urea price, has fallen (in theory) from 1:3 in 1997-98 to 1:26. However, the minimum paddy procurement price is above the import price, and paddy at harvest was actually selling for as little as Rp. 900/kg. The minimum procurement price only affects about 10 percent of the harvest. The paddy:urea price ratio has therefore fallen to about 1:1. Even at this ratio (assuming a conservative yield response of 3 kg paddy per kg urea), the value-cost ratio (VCR) is over 3, well above the level required to induce farmers to continue to use urea. The fall in the VCR can be expected to reduce demand somewhat, but the increased availability of credit should minimize the fall in demand. Excessive use of highly subsidized urea will be reduced, and the impact on paddy production can be expected to be slight. In the estate crop sector, higher crop realizations benefiting from devaluation will ensure a continued increase in fertilizer demand. Crop Intensification Programs. The fertilizer market in Indonesia, especially in Java, is mature; farmers are well aware of the benefits of fertilizer use. Thus, access to, availability, and ability to purchase fertilizer at prices which provide economic returns to farmers are the critical factors in determining use. Technology transfer to improve efficiency of use is nullified when these conditions do not prevail. The government’s crop intensification schemes do not necessarily have to be integrated with the marketing system or exclude bureaucratic controls over farmers to achieve better productivity. However, the significant fall in phosphate use and the very low use of potash are matters of concern and indicate that the extension services have not performed very well. This situation needs to be addressed through both the extension services and the marketing system. Domestic Fertilizer Production Costs. Urea production costs are estimated to be between US$61 and US$65/mt. In 1998 the PKG urea plant operated at only 50 percent capacity because of technical problems that resulted in a production cost of about US$97/mt, uneconomic by world standards. Overall, production costs of urea are internationally competitive for regional markets in Southeast and East Asia. Urea production energy efficiency has on average been improved to approximately 30 MM Btu/mt, ranging from 24 MM Btu/mt for the newest plants to 34 MM Btu for revamped older plants. Operating efficiencies, particularly in plant turnaround times, maintenance costs, and operating labor productivity could still be improved. Phosphate fertilizer production costs at PKG are not competitive with those in North America or North Africa. Current ex-factory prices are competitive with c.i.f. prices in East Java but not in North Sumatra due to high freight costs. Production costs were reduced in 1999 when factories gained access to by-product sulfuric acid from a copper smelter. Natural Gas Pricing. Indonesia has proven gas reserves of 137.8 trillion cubic feet and annual utilization (including flares and losses) of 3.17 trillion cubic feet. Liquefied natural gas accounts for 54.1 percent of use and fertilizer production for 7 percent, or 620.1 million s.c.f. per day. Contractual prices for various industries are shown below: 54 Fertilizer: PUSRI IB US$1.50 /MM Btu PUSRI II, II,IV US$1.85/ MM Btu KALTIM US$1.00 /MM Btu KUJANG US$1.50/MM Btu PIM US$1.00/MM Btu PKG US$2.00/MM Btu KALTIM (additional gas) US$1.85/MM Btu Methanol US$1.50/MM Btu PT Krakatau Steel US$1.32/MM Btu PT Krakatau Steel (1999 on) US$2.00/MM Btu Ceramic Industry US$2.10/MM Btu plus transportation cost LNG US$1.20/MM Btu The argument has been advanced that the price of natural gas when used as feedstock for fertilizer should reflect the opportunity costs of alternative markets. The prices shown above for nonfertilizer markets (except LNG), are not market prices and therefore should not be used to justify the pricing of gas for fertilizer. High gas production and distribution costs in East Java are reflected in the PKG contract price of $2/MM Btu. The price of natural gas should provide an adequate return for gas exploration, production, and transmission while also ensuring competitiveness for fertilizer manufacturers in international markets and adequate government revenue. Most of Indonesia’s oil and gas exploration is carried out by contractors under production sharing contracts on a profit-sharing basis with the government. The contractors get 58 percent of the profits, GOI 42 percent. Recent calculations by the Department of Basic Chemical Industries16 indicate that government revenue per MM Btu from LNG export sales is about US$0.8517 at a gas price of US$1.20/MM Btu. By comparison, government revenues from urea manufacture are about US$1/MM Btu with gas priced at US$1.50/MM Btu. Internationally, the price paid by the fertilizer industry for natural gas varies from US$0.25/MM Btu in the Middle East to more than US$3/MM Btu in Western Europe. The lowest cost producers of urea competing with Indonesia in regional export markets are Russia and several Middle East countries. Russian natural gas has recently fallen to about US$0.40/MM Btu, while prices in the Middle East range from US$0.25 to US$0.50/MM Btu. Urea freight costs from the Black Sea to South East Asia are about US$25/mt, from the Middle East about US$15. At new plant gas utilization rates of 25 MM Btu/mt urea, Indonesia has a freight advantage of approximately US$1 compared to the Black Sea ($25/25 MM Btu) and US$0.60 compared to the Middle East ($15/25 MM Btu). Russian urea from Black Sea ports sets the international floor price for urea, and therefore, Indonesian urea producers are internationally competitive with a gas price of around US$1.50/mt. 16 Ministry of Industry and Trade, Multiple Benefit from the Utilization of the Natural Gas for Domestic Industry, Jakarta, November, 1998. 17 The calculations for government revenue from LNG production omit income tax on employees, so actual revenue should be slightly higher. 55 With a border parity pricing system for fertilizer, natural gas prices should reflect international fertilizer price movements to avoid either undue burdens (or windfall benefits) on either farmers or manufacturers. Initial calculations indicate an average price of US$1.50/MM Btu when f.o.b. urea prices are US$140/mt and should be varied by US$0.10/MM Btu for each US$10 change in f.o.b. prices for urea. A similar system has been employed by the government of Trinidad and Tobago to provide equity to ammonia producers and to the government. A simple formula for sharing risk between natural gas and fertilizer producers is at the end of this paper. Distribution Monopoly. The cost of urea distributed by PUSRI averages Rp. 350,000/mt. This overall cost includes the freight cost for bulk product from factories to bagging stations, bagging costs, freight costs for bagged product from bagging stations to regional warehouses, inventory holding costs, freight costs to distributors, distributors’ margin, the supervisory costs of KUDs, and a fixed profit margin (see Table 5). The system does not provide sufficient incentive for efficiency improvement and would need to be deregulated in a liberalized system to avoid a private sector monopoly. Options include privatization or leasing of bulk urea carriers, bagging stations, and regional warehouses, either as single entities or in asset packages. The private sector already operates portable bagging units, and therefore regional monopoly of bagging is avoided. The PUSRI domestic marketing department should be legally separated from the production company as the first step in deregulating domestic production. Market Liberalization. The urea market has been deregulated in that trade by both the private sector and non-KUD cooperatives is allowed in both the food crop and plantation sectors. In addition, the private sector is allowed to import fertilizer. In the food crop sector, however, cooperatives and the private sector do not have equal access to subsidized farm credit, and there is little incentive for private sector importers to establish marketing networks except for the non-rice and plantation crop markets. Farm production credit programs need to be de- linked from retail suppliers of farm inputs, or else equal credit opportunities should be provided to all potential marketing organizations, whether cooperative or private. Since December 1998, private sector firms have imported only small quantities of urea, AZ, TSP, and potash. These imports were made in response to tenders issued first by the Ministry of Agriculture and then by the Ministry of Cooperatives and Small Enterprises. Six private sector companies were issued import licenses by the Ministry of Trade and given access to L/Cs by the Ministry of Finance. The companies were unable to obtain L/Cs without Ministry of Finance backing. Since the planting season was over when the fertilizer arrived and the companies did not have distribution networks, the fertilizer was sold to PUSRI, which was under instructions to purchase it if the importers wanted to sell it. That allowed the companies to avoid inventory costs, and was not a liberalization of import procurement but creation of a system prone to rent-seeking and patronage. The absence of developed market networks other than the PUSRI system and KUDs will continue to impede the development of competitive importing. Potential private sector importers must go beyond procurement deals of this kind and create new marketing channels. The inferior performance of most KUDs is due to access to subsidized credit, their poor repayment records, and generally inferior management. 56 The new cooperatives and associations being formed are still an unknown quantity. Importers of NPK fertilizer and micronutrients for the plantation sector reduced operations significantly following the devaluation of 1997 and competition from subsidized fertilizer leaking out of the food crop sector. This problem would be cured by market pricing or administered border parity pricing. Liberalized Fertilizer Marketing in Java. The large fertilizer market in Java is the key target for market liberalization. At least two options are available for promoting this liberalization: · Phase out PUSRI marketing in the Java market and allow any licensed business to buy fertilizer from any and all sources. As cooperatives and private sector companies get more experience, they can be expected to acquire an increased share. · Allow each of the four production companies serving Java (PUSRI, KALTIM, KUJANG, and PKG) to market their own production. Holding companies in market economies frequently encourage market competition between their subsidiaries to improve customer service and marketing efficiency. PUSRI is considering the parceling out of its domestic marketing department to its subsidiary companies. This would include assigning marketing staff to the subsidiaries and assigning them fixed marketing areas. There is no need for such a restriction. Each subsidiary should have the freedom to sell its products in any location. Transport economics will largely determine the most efficient marketing areas, and there will be competition between the companies at market borders. The advantages, compared to the option of setting up a domestic marketing department within each subsidiary, are these: · Rapid transition (6 months) to competitive marketing. · The ability of the production companies to help private sector companies and cooperatives develop marketing expertise. · The financial ability of existing companies to import fertilizers. · Competition could be established in areas outside Java. · Ex-factory product pricing could be imposed at border parity equivalency until private sector imports (either in reality or as a perceived threat) provided the competition to maintain ex-factory border prices. · The subsidiaries, with greater control over their domestic marketing, would be better candidates for privatization. · Privatization of the individual subsidiaries would prevent the privatizing of a monopoly. Liberalizing Fertilizer Markets in Remote Areas. Transferring responsibility for domestic marketing to the subsidiary companies would not change distribution patterns immediately. However, remote area marketing (as explained earlier) is expensive. The GOI has approved transport/distribution subsidies for these areas, implying that PUSRI will continue to bear the high administrative costs. These costs could be transferred to the subsidiaries prior 57 to privatization, but the government would need to consider nonmarket interventions, such as fertilizer vouchers or direct income support to farmers, to compensate for high delivery costs. Fertilizer Regulatory System. With state controls, title to fertilizer remains with the government until the fertilizer is purchased by farmers. Under a liberalized system there would be a need to enact legislation to safeguard farmers from product adulteration, mis-labeling, and incorrect weights. These controls should include a requirement for truth in labeling. Fertilizer Market Information System. PUSRI currently controls access to fertilizer market information on demand, inventory, prices, and marketing costs. Retail fertilizer prices are now displayed in all KUDs, but demand, price, and inventory information is needed by all participants in the system to ensure efficiency. The GOI would need to ensure that such information is disseminated on a regular basis to all participants. Privatization Of The Current Production Companies · Privatization of the six fertilizer SOEs would provide the following benefits: · Improvements in enterprise efficiency (reducing the costs of operations) and effectiveness (increasing the range and quality of products). · Revenue to the government. However, as discussed previously, a number of matters need to be resolved. The major strategic decisions concern the timing of the privatization, the modality of privatization (IPO, trade sale, management buyout), whether the enterprise should be privatized in whole or part, major investment decisions prior to privatization, and whether any restructuring of the industry should be undertaken prior to privatization. The Ministry of State-Owned Enterprises has plans to privatize the fertilizer sector, commencing with KALTIM and PUSRI. While all of the SOE fertilizer plants are viable, the international nitrogen fertilizer industry is currently depressed, and it may be hard to find buyers. However, going ahead with privatization of one or two companies as soon as the necessary regulatory and structural changes are in place would test the market. Sale of the companies to the highest bidders appears to offer the best alternative once the international market improves. If the fertilizer holding company (PUSRI) were privatized, the sheer size of the company would restrict the number of potential purchasers and probably reduce the price below the total sum that would be obtained through separate privatization of each of PUSRI’s subsidiaries. Three expansions are planned by the fertilizer industry. These are PIM II (a 1,750 tpd ammonia/urea facility), KALTIM IV, and a PKG 300,000 tpy NPK granulation plant. The PIM project has been financed, and construction is commencing. Generally, however, large investment decisions should be avoided prior to privatization; instead, the new owners should be allowed to make these decisions. Fertilizer sector investment decisions, on the other hand, are very cyclical, and are usually made too late on rising markets. The timing of both the PIM 58 and KALTIM projects should not be delayed and will not affect the prospects for privatization. However, the PKG plans for investing US$70 million in NPK granulation appear difficult to justify. Greater priority should be given to overcoming urea production problems, with decisions on NPK left until after privatization. Policy Conclusions And Recommendations 1. To achieve the twin objectives of providing Indonesian farmers with adequate supplies of internationally competitive priced fertilizers and internationally competitive private companies, the GOI needs to undertake further policy reforms within a strategic framework aimed at providing a fully liberalized and regulated market. The transition process needs to be carefully planned to avoid market shocks and disruptions. The abrupt removal of fertilizer subsidies should not be repeated. 2. A comprehensive regulatory system for fertilizer needs to be enacted as soon as possible to provide quality assurance to farmers based on truth-in-labeling and enforced with penalties for noncompliance. 3. The PUSRI distribution monopoly should be separated from the production company and disbanded. It is recommended that regional and head office staff be transferred to each of the subsidiaries of PUSRI to form nuclei with domestic marketing experience for marketing departments in those companies. 4. Each new company should be made responsible for the domestic marketing of its own urea and for the procurement and marketing of other fertilizers from domestic and international sources. Each company should be free to establish marketing networks utilizing KUD, other cooperatives and associations, and private sector firms. Each subsidiary should be given first right of refusal for the transfer of PUSRI marketing assets (bagging units and warehouses). 5. Prior to privatization, fertilizer prices can continue to be administered at the ex-factory level at appropriate border prices, but all other prices should be decontrolled. A preferable option would be to decontrol all prices as soon as the new marketing arrangements are in place. This would allow each company to decide on seasonal price variations. 6. Freight subsidies may be considered for fertilizer deliveries to remote areas; current commitments by PUSRI to remote areas should be honored. Prior to privatization, it is recommended that the GOI develop either a fertilizer voucher system or direct income support for farmers for fertilizer purchases in remote areas. 7. Prior to privatization, the companies should be encouraged to implement plans for training market participants (KUDs, other cooperatives, associations, private sector firms) in all aspects of fertilizer procurement and marketing. 8. The banking system’s facilities for the distribution of credit for purchases of fertilizer is inadequate. 9. The PUSRI marketing infrastructure assets not required for PUSRI’s marketing network should be privatized if not needed by the other subsidiaries. 10. Subsidized farm production credit and fertilizer sales should be de-linked at retail outlets, and individual farmers and farmer groups should be free to purchase fertilizer from any retailer. 11. A long-term natural gas pricing formula should be developed which relates prices to the international price of urea to prevent windfall profits for fertilizer production companies and to avoid cost burdens on farmers. 12. Privatization of the fertilizer companies should be delayed until the above reforms are in place. 59 Fertilizer Policy Matrix Policy Area Current Constraints Policy Objectives Actions By October 1999 By June 2000 By June 2001 Policy framework Continued administration and Liberalization and privatization Announce plans to bureaucratic control liberalize and deregulate the sector and privatize the fertilizer companies Fertilizer No comprehensive system To provide a regulatory Begin implementation Enact legislation Regulatory and no quality assurance for framework for fertilizer and enforcement System farmers marketing quality assurance and an effective means of enforcement Transfer domestic Monopoly distribution system Increased competition and Announce implementation marketing efficiency immediately to take effect operations to Transfer of PT Pusri marketing by October 1999; subsidiary skills and information to Transfer distribution companies subsidiaries system assets to subsidiaries or lease or dispose to private sector Competitive Monopoly distribution system Focus on competitive marketing New marketing system marketing and unequal access to in Java initiated with KUJANG, subsidized credit channels PKG, KALTIM and GRESIK competing for market share on Java utilizing their own marketing networks comprising any combination of cooperatives, associations, private sector and own facilities; Likewise for PUSRI and PIM in Sumatra and Cooperative, association and PUSRI and KALTIM in private sector access to other areas. commercial distribution credit See credit policy matrix De-linking of farm production 60 credit from market network See credit policy matrix Fertilizer Pricing Administered quarterly 1. Market based pricing Administer ex-factory prices quarterly based on either cif or fob prices 2. Incentives for inventory Allow complete build-up to meet peak demands freedom of ex- factory prices including seasonal price variations to Pan-territorial pricing meet objective 2 Market-based pricing with full Implement freight recovery freight cost recovery immediately Fertilizer Use Unbalanced use of fertilizer in Fertilizer company marketing Coordinated Continued long Efficiency food crop sector departments, in conjunction campaigns by term marketing with extension service, need to extension service activities to increase field demonstrations and marketing promote benefits and technology transfer to departments of of balanced retailers and farmers fertilizer companies fertilizer applications Remote Area Currently subsidized through Maintain economic fertilizer In conjunction with Evaluate and Subsidies freight equalization, prices for remote areas, implementation of freight implement either a penalizing farmers in Java especially where transmigration recovery in other areas, fertilizer voucher programs have encouraged provide direct freight system for remote paddy production subsidies for remote areas areas or direct income support program coupled to full freight costs Market Controlled by PT Pusri and Provision of market signals – Increase BIMASS Develop private Information not disseminated, leaving price, inventories, demand collection and sector market System other market participants estimates – to all market dissemination of fertilizer information bereft of market information participants market information; systems through for planning and Weekly price reports trade association implementation purposes during peak demand periods Natural Gas Administered prices and Market based pricing related to Develop and implement a Pricing Policy subsidized contracts international urea prices and variable price, risk sharing adequate returns for gas gas pricing policy producers 61 Determine overall Holding company monopoly Privatize individual subsidiaries Determine a privatization to optimize asset realization marketing policy for policy privatization order Prepare High employment levels and Determine whether to reduce Conduct detailed financial Continue Continue Enterprises for regional development employment and development and operational investigations of investigations of sale commitments to GOI obligations prior to privatization investigation of first next companies to last companies to enterprise to be privatized be privatized be privatized. Conduct Sales Requires upturn in Optimize assets Carry out sale Continue for international nitrogen market process; prepare other enterprises. for best results bidding documentation, undertake marketing, carry out bidding, and manage closing arrangements for first company to be privatized 62 APPENDIX I: A PROPOSED NATURAL GAS PRICING FORMULA FOR THE FERTILIZER INDUSTRY Objectives: 1. Provide an indigenous natural gas pricing formula based on market prices. 2. Provide sufficient incentive to natural gas producers to cover production, exploration, and development costs. 3. Provide natural gas to fertilizer producers in Indonesia at a cost that allows them to be competitive with international regional suppliers of urea and ammonia. 4. Optimize GOI income from natural gas production and use. 5. Provide an equitable cost/benefit sharing between natural gas producers and natural gas users. Principles: 1. Set a negotiated natural gas price for each natural gas field that provides an adequate return for production, exploration, and development. 2. Relate the above price to a fixed international urea price f.o.b. Indonesia. 3. Adjust the price to fertilizer producers, using a 3-month moving average international urea price f.o.b. Indonesia. 4. Share the gains or losses from international urea price movements between natural gas producers (one-third) and natural gas users (two-thirds). Application: Base Negotiated Contract Price International Reference Urea Price For Fertilizer Producers US$/mt bulk f.o.b. Indonesia or c.i.f. bulk. (Including distribution) US$/MM Btu East Java $2.00 $150.00 (c.i.f.) West Java $1.50 $150.00 (c.i.f.) Sumatra $1.50 $140.00 (c.i.f.) East Kalimantan $1.50 $140.00 (f.o.b.) Cost sharing formula: For each change from the reference price of $1.00/mt in the 3 month rolling average urea price, the delivered natural gas price would be changed by $0.01 / MM Btu from the base price. Pricing Results from Past Market Data Applying this formula over the past six years, which has included periods of both high and low prices, results in gains and losses split approximately one-third to natural 63 gas producers and two-thirds to urea producers. It would have provided average net gains per ton of urea of $5.45/mt for natural gas producers ($1.68/MM Btu) and $12.71/mt for urea producers (see table). Similar outcomes would have occurred with $2.00 gas price and $150 urea price. Table 5: Variable Natural Gas Pricing For Fertilizer Production Urea Urea Gas Price Gas Prod Urea price Price Prod Quarter fob bulk Variation Gain/Loss Gain/Los s $/mt $/mt $/mt urea $/mt urea Dec-93 $117.20 -$22.80 1.27 -$6.84 -$15.96 Mar-94 $117.10 -$22.90 1.27 -$6.87 -$16.03 Jun-94 $133.70 -$6.30 1.44 -$1.89 -$4.41 Sep-94 $162.10 $22.10 1.72 $6.63 $15.47 Dec-94 $180.50 $40.50 1.91 $12.15 $28.35 Mar-95 $233.40 $93.40 2.43 $28.02 $65.38 Jun-95 $194.70 $54.70 2.05 $16.41 $38.29 Sep-95 $208.00 $68.00 2.18 $20.40 $47.60 Dec-95 $229.90 $89.90 2.40 $26.97 $62.93 Mar-96 $221.60 $81.60 2.32 $24.48 $57.12 Jun-96 $215.20 $75.20 2.25 $22.56 $52.64 Sep-96 $206.10 $66.10 2.16 $19.83 $46.27 Dec-96 $187.20 $47.20 1.97 $14.16 $33.04 Mar-97 $176.60 $36.60 1.87 $10.98 $25.62 Jun-97 $155.80 $15.80 1.66 $4.74 $11.06 Sep-97 $130.80 -$9.20 1.41 -$2.76 -$6.44 Dec-97 $102.20 -$37.80 1.12 -$11.34 -$26.46 Mar-98 $99.40 -$40.60 1.09 -$12.18 -$28.42 Jun-98 $113.90 -$26.10 1.24 -$7.83 -$18.27 Sep-98 $104.50 -$35.50 1.15 -$10.65 -$24.85 Dec-98 $98.70 -$41.30 1.09 -$12.39 -$28.91 Mar-99 $90.80 -$49.20 1.01 -$14.76 -$34.44 Average $158.15 $18.15 1.68 $5.45 $12.71 Reference urea price $140/mt bulk f.o.b. Reference natural gas price $1.50 / MM Btu Based on 30 MM Btu /mt urea. 64 VI. SEEDS COMMERCIALIZATION OF THE SEED INDUSTRY The Indonesian government’s vision is to create an enabling environment for privatizing and commercializing the seed industry. A dynamic commercial seed industry would facilitate the flow of high-yielding and high-quality seeds to smallholders. The seed industry in Thailand comes close to being such a vision. In Thailand, farmers benefit from a large variety of quality seeds at competitive prices, often making them the lowest-cost component among farmers’ purchased inputs.18 Seeds determine plant yields and contain the genetic characteristics of value to producers and consumers. Thus, farmers’ access to such seeds is important in revitalizing agriculture. The extent to which farmers exploit the productivity potential of modern seed varieties depends on the use of the entire technology package, of which seeds are but one component. The close link between how widely and how well quality seeds are used and the profitability of agriculture has important implications for the steps needed to achieve a dynamic seed industry in Indonesia. The Formal Seed Industry in Indonesia As in most developing countries, Indonesia’s informal seed sector (local traders and seed producers, including farmers who are not subject to rules on varietal development, registration, and certification) is much larger than the formal seed sector. The latter, however, has four characteristics with important implications for further development. The formal seed sector (public and private) is small in terms of number of companies and scale of operations in major food crops except for paddy. There are two state-owned enterprises: Sang Hyang Seri (SHS) (Persero), established in 1971 with the assistance of a World Bank loan, and PT Pertani (PTP), which was established in 1959 but did not enter the seed business until 1986. SHS and PTP dominate the market for paddy seeds. In addition, there are ten private sector companies which produce mainly hybrid corn and horticultural seeds and thus do not compete with the SOEs.19 SHS and PTP jointly supply roughly a third of all high-yielding varieties of rice. Some of the private firms which undertake breeding of seed varieties are BISI (research and production) and Tanindo (marketing) mainly hybrid (horticultural, corn, and paddy seeds), Pioneer-Hibrida (hybrid corn seed production), East-West Seeds-Indonesia (hybrid corn and horticultural seeds), and Monsanto-Indonesia (corn, cotton, teak, 18 Estimates for paddy and corn show that the costs of seeds range from 2 to 4 percent of total input cost. 19 “Private sector agricultural research and technology transfer in Indonesia”, by Keith O. Fuglie, International Potato Center, Bogor, Indonesia. January 1999. 65 eucalyptus). Although these firms produce hybrid corn seed, use of hybrid seed is only 10 percent of annual use (about 7,000 tons of hybrid corn seed out of a total of 70,000 tons). (In Thailand, on the other hand, over 90 percent of corn hectarage is planted with hybrids.) In the conceptual framework of four stages in the evolution of a maize seed industry—pre-industrial, emergence, expansion, and maturity —Indonesia’s is at the emergence stage.20 Sales of paddy and soybean seeds by the two SOEs are subsidized. 21 In paddy, the subsidy has helped raise HYV seed use to one of the highest levels in Asia, estimated at 24 percent of total in the early 1990s. Currently, it is believed to be roughly 37 percent countrywide and 50 percent in Java. The self-pollinating nature of current paddy seed varieties and the subsidies combine to crowd out private-sector paddy seed. In soybean seed, on the other hand, the subsidy has had a limited impact. In the early 1990s, use of HYV soybean and corn seeds was estimated at 1 and 4 percent, respectively.22 Many private seed companies in Indonesia are subsidiaries of multinationals, getting parent seed from the United States, Thailand, and the Philippines, among others. BISI’s mother company for example, is Charoen Pokphand, of Thailand. BISI also obtains parent seeds from Dekalb Genetics in the United States. All of the private companies utilize similar marketing strategies. They segment their markets and undertake extension and demonstration activities to expand demand for their seeds, they place great emphasis on maintaining seed quality, and they focus on hybrid seeds, which more or less eliminates farmer reproduction of the seeds. Hybrid seed can be reproduced only by those who know the pedigree or who have access to parent lines. 23 Except for Pioneer-Hibrida, the companies have diversified beyond seeds into agro-chemicals, farm machinery, and agro-processing, not only to reduce business risk but also because seeds are just one component of the technology package sold by the companies. Their marketing strategies are demand-driven, unlike those of the SOEs, which are supply driven. The Institutional And Regulatory Framework Indonesia’s regulatory framework for seeds consists of research institutions, and regulations governing varietal development, release, and certification, and the import and 20 “Maize Seed Industries, a Conceptual Framework”, by Michael L. Morris, Joseph Rusike, and Melinda Smale, in Maize Seed Industries in Developing Countries, ed. by Michael L. Morris, Lynne Rienner Publishers, CYMMIT. 21 SHS and PTP receive the same per unit subsidy and profit guarantee. According to SHS, the subsidy per kg of paddy in 1998 was Rp 200.00 (estimated), and Rp 399.11 (actual). The guaranteed profit margin was Rp 65.00 per kg. The actual subsidies per kg have risen from Rp 220.91 in 1990 to Rp 399.11, the profit guarantee from Rp 40.64 to Rp 65.00. (Source: Perkembangan Subsidi Benih, Tahun 1990-1998). The subsidies are paid directly to the companies 22 “Seed quality of secondary crops,” by Udin S. Nugraha, H. Smolders, and Nassir Saleh, in Integrating Seed Systems for Annual Food Crops, proceedings of a workshop held in Malang, Indonesia, October, 1995. 23 Hybridization gives firms control over seed supply. Farmers lose that control but gain to the extent that hybrids have more desirable properties, such as high yields and pest resistance. Maize Seed Industries in Developing Countries, edited by Michael Morris, Lynne Rienner Publishers, CIMMYT. 66 export of plant varieties. 24 Indonesia is also a member of the Asia Pacific Seed Association (APSA). At the top of the institutional structure is the National Seed Board (NSB, established 1971), which formulates regulations on seed production and marketing. It also advises the MOA on the release or withdrawal of seed varieties, on seed certification, and on the supervision of seed production and marketing. Its approval is also required for seed imports. Its members are from several government departments, including the National Planning Board, the Bank of Indonesia, the Agency of Agricultural Research and Development (AARD), the Directorate of Food Crops and Horticulture of the MOA, and cooperative and seed certification agencies. Notably absent (unless cooperatives are considered formal and private) are representatives from the formal private sector. The AARD’s Central Research Institute for Food Crops (CRIFC) is one of seven research centers (the others deal with rural socio-economics, horticulture, industrial crops, animal science, fisheries, and agricultural machinery). The CRIFC undertakes varietal development and produces breeder seed, which is then submitted to the NSB, which decides whether to carry out further development in the system of state-owned and managed seed farms which produce foundation seed, stock seed and extension seed. The Research Institute for Rice (RIR) at Sukamandi collaborates with the International Rice Research Institute (IRRI) in the Philippines and the two SOEs to develop rice varieties. Breeding programs for local seed adaptation usually take four to five years. Although RIR does not have a formal monopoly on rice research, it has a de facto monopoly. Since intellectual property rights to seed varieties do not exist yet in Indonesia, the private sector is only interested in rice hybrids. A draft law on plant variety protection (PVP) was submitted by the RIR to the cabinet in 1998, but no further action has been taken. The Varietal Release and Registration Committee of the NSB enforces the regulations on compulsory registration of seeds. Breeder seeds imported by private sector firms must undergo multilocational testing, which used to involve twenty different locations and take an average of one to two years. The process has now been simplified and shortened. After multilocational testing, the results are submitted to the NSB for formal approval. Several directorates within the MOA deal with seeds. The Directorate General of Food Crops Agriculture, the Directorates of Paddy and Palawija Production Development, and the Directorate of Seed Development (which comprises the sub directorate of Seed Production, the sub directorate of Seed Control and Certification, and the Seed Control and Certification Service (SCCS), implement regulations on certification. Seeds are classified as public (paddy, corn, soybean) and commercial (horticultural, hybrid corn) seeds. Certification assures that the seeds are from the stated cultivar; what is certified is the truth of the producer’s statement about parentage. The process gives assurance with respect to genetic purity, homogeneity, germination rate, 24 The basic regulations are Law No.12/1992, Government Regulation No. 44/1995, Decree of the Minister 902/1996, and Decree of the Minister 803/1996. 67 physical purity, and water content.25 Certification is usually valid for a period of six months, except for soybean seeds (which get only three months because their freshness is critical). The SCCS dispenses white (FS), purple (SS), and blue (ES) labels for certified seeds. If unsold after the expiration date, seeds have to be re-certified. Although certification is in principle required of all seeds sold by the formal sector, it is usually not applied to horticultural seeds.26 Private firms believe their internal quality control procedures to be more reliable than certification by a public agency. Hybrid corn seed, however, usually must undergo certification tests. The two SOEs are active at all levels, from varietal development (selection, yield trials, and multilocation tests) to the processing and sale of paddy and other seeds. Like the research institutes and the state-owned seed farms, they work with contract farmers and cooperatives. Most of their seeds are sold directly to government projects. At times, SHS and PTP also sell directly to farmers through farmers’ organizations (kelompok tani). SHS, for example, produces Jabal (interfield) soybean seeds with pink labels which are sold directly to farmers’ organizations instead of the usual network of distributors.27 Blue-labeled seeds show genetic origin, whereas pink-labeled seeds are of unknown genetics or location. Strictly speaking, pink-labeled seeds are not certified. Importation of plant varieties (as well as fish and animal species) is regulated by: (a) permission from the MOA to import; (b) receipt of a sanitary and phytosanitary (SPS) certificate from the exporting country; (c) payment of customs tax; (d) quarantine for testing and field observation. Because of the absence of PVP, firms consider the release of samples for testing to be a risk. The entire process, paid for by the company, takes two to three weeks on average. To avoid bureaucratic difficulties, some companies pay forwarding agents to handle the entire import process. For exporting plant materials, only an SPS certificate is required. Apart from the absence of a law on intellectual property rights to seeds, there is no law requiring truth-in-labeling to protect seed purchasers. If applied correctly, certification would ensure quality, but it does not, as discussed below. Impact of Government Policy on the Seed Industry Indonesia should be recognized as having two major achievements with respect to seeds: a well-developed institutional structure that can be used to further develop the industry, and the extensive use of certified paddy seeds that contributed to yield growth. Unfortunately, paddy yields began to stagnate in the 1990s, raising the question of the extent to which seed policy has been responsible for this stagnation. Specifically, has the monopoly held by public research institutes and SOEs in rice breeding, multiplication, and sale denied farmers access to a wider range of higher yielding seeds? 25 Seeds reproduced on farmers’ fields may also have desirable germination, yield, and other qualities. Uncertified seed should not be equated wit h poor quality seeds. 26 Lack of budgetary resources was given as the main reason for not insisting on certification for horticultural seeds. 27 “Market for Palawija Seed in Indonesia”, by Peter C. Schoeder and Eko Legowo, in Integrating seed system s, op. Cit . 68 There are various reasons for thinking that has not been the case. First, the pubic sector monopoly came into existence largely because the private sector is not interested in paddy, whose seeds are self-pollinated (farmers can reproduce them), whose sales are subsidized, and whose intellectual property rights are not protected. Indonesia fits the general pattern of developing countries, wherein public sector and farmers’ own- generated seeds dominate in self-pollinated crops.28 Second, the CRIFC continues to work closely with IRRI, and IRRI-developed varieties are available for testing in Indonesia. Indeed, Indonesia has released many varieties since 1986.29 Third, since the Green Revolution in the 1970s, there have been no new breakthroughs in paddy yields. IR-64 remains the most popular variety because yield and grain quality are superior to later releases. (It is, however, susceptible to bacterial red stripe and tungro diseases). Fourth, there is still a substantial gap between actual average yield and the levels achieved through best practices: 3 tons/ha versus 5 t/ha of husked rice, or 5 t/ha versus 8 t/ha of dry, clean, and unhusked paddy. Thus, improving yields depends on closing this gap, which has nothing to do with getting better access to supplies of seed varieties. The gap is due to the status of other factors, such as on-farm adaptation, delivery of extension services, access to agro-inputs, the quality of processing, storage, marketing facilities, and security of land tenure. Membramo, released in 1995 has higher yields but has problems of lodging and inferior grain quality. A modified IR-64 variety developed by IRRI is currently being tested by researchers in Indonesia. It retains the yield and the grain quality of IR-64 but is more resistant to tungro. There are also two major problems in the present arrangements: the current regulations inhibit the expansion of private sector participation in the seed industry without necessarily protecting seed users from fraudulent supplies, and policy compartmentalizes the seed industry between its public and private sectors and its formal and informal sectors, thus foregoing synergistic interaction between them. The limited role of the private sector is largely a consequence of over-regulation. The ultimate losers are farmers and the overall economy, since a curtailed private sector reduces the number of varieties available at competitive prices. In countries with advanced seed systems, such as Thailand and Chile, the private sector plays a major role. The regulatory framework is supportive of, instead of inhibiting, the private sector. Such things as compulsory multi-locational testing, obligatory registration before the release of a new variety, obligatory certification before sale, and quarantine regulations unsupported 28 The only exceptions are Chile and Argentina, where the private sector enjoys breeders’ rights. In both countries, the private sector has undertaken research on creating crop varieties suitable for specific agro-ecological areas. “The roles of the private and public sectors in enhancing the performance of seed systems, “ by Steven Jaffe and Jitendra Srivastava, in World Bank Observer, vol. 9, no. 1, January 1994. 29 Since the release of IR-64 in 1986, Indonesian research has released 28 rice varieties up to Apo Buru in 1998. Source: Deskripsi Varietas Padi. Padi Sawah, Padi Gogo, Padi Lebak/Padi Pasang Surut. Direktorat Jeneral Tanaman Pangan Dan Perbenihan, 1998. Memberano, released in 1995, has higher yields but has problems of lodging and inferior grain quality. A modified IR-64 variety developed by IRRI is currently being tested by researchers in Indonesia. It retains the yield and the grain quality of IR-64 but is more resistant to tungro. 69 by scientific concern increase the costs of operations in the private sector without necessarily improving seed quality or protecting purchasers. There is no doubt that government has an important role to play in protecting consumers from fraudulent claims, given that the inherent qualities of seeds are not visible to the naked eye. The issue is not whether the government should protect the public, but how best to do it. One issue is whether the current regulatory controls actually ensure quality.30 Because of budget constraints and lack of accountability to independent evaluators, standard scientific procedures in developing breeder seed are not followed and seed testing methods are not reproducible, weakening the validity of test results.31 Since agriculture is a linked chain of activities, quality problems in seeds are passed on to later stages of the chain. The current system combines inflexible application of the rules (the rules applied to all crops) with faulty application. A second issue is whether the objective of consumer protection can be achieved more cost-effectively. In Thailand, registration and certification are voluntary. The United States also has a system that encourages competition, with registration and certification both being voluntary. 32 It has been proposed that the absence of registration and certification and certification procedures for horticultural crops in Indonesia should be extended to other crops. Private firms themselves ensure the quality of horticultural seeds, because they know that otherwise farmers will not buy them. Farmers always have farm-produced seeds as an alternative. Hence, it is sound strategy to ensure quality, but the government should consider more flexible ways to achieve quality control. According to advocates of the four-stage evolution of seed systems, the compartmentalization found in Indonesia’s seed sector is a matter of concern. 33 The problem is not the predominance of farmer-saved seeds, which prevails even in Thailand but the lack of collaborative arrangements between public and private.34. Seed policy in Thailand has always encouraged private investment in breeding and downward seed multiplication and processing. Private sector breeding activities commenced in the late 1970s when private firms began further work on the successful corn varieties developed by Kasetsart University, the most important public sector player in hybrid corn industry in Thailand. In many developing countries with advanced seed systems (e.g., India, Brazil), private sector research on hybrids relies on the public sector to supply germplasm and inbred lines, and to train scientists and other skilled personnel, among other things. Breeding is very costly in terms of skilled personnel and equipment and it is therefore no accident that the organizations involved in breeding are multinationals and joint ventures. 30 Note that quality for seeds from the formal system is defined strictly for certification. The looser definition of quality for seeds from the informal system refers to any set of properties judged desirable by farmers themselves. 31 Project Digest, draft paper by Udin S. Nugraha, Ph.D, January 1999. 32 “Comparing the EU and US seed regulatory system”, by Jim Elgin, in Easing barriers to movement of plant varieties for agricultural development, ed. by David Gisselquist and Jitendra Srivastava. World Bank Discussion Paper no. 367, 1997, World Bank, Washington, D.C. 33 “Supporting integrated seed systems: Institutions, organizations, and regulations”, by Robert Tripp, in Integrating Seed Systems for Annual Food Crops, op. cit . 34 “Private sector agricultural research in Thailand”, by Keith O. Fuglie, draft January 1999. Table 6 shows that of the 700,000 tons of seed needed annually, only about 80,000 tons are provided by commercial companies and government agencies. 70 By facilitating access to its breeder lines the public sector would encourage the entry of small and medium-size local firms into the seed business, thus facilitating the integration of formal and informal systems, and raising quality standards in the latter. In other countries, public participation in seed development is undertaken by contract to the private sector, often with performance clauses in the contract. Options for Commercializing the Seed Industry The government is aware of the shortcomings of the current system, and the Ministry of State-Owned Enterprises (SOE) has decided to restructure the SHS and PTP during calendar 2000, with both organizations focussing on their core business: seeds in the case of SHS, and other agricultural inputs by PTP. The objective is to make them profitable without subsidies and then to privatize them. To improve the functioning of the public seed sector, the government is also considering (a) allowing public research institutes to sell breeder seeds to private contract growers instead of channeling them mainly to state-owned farms, so as to improve the supply of breeder seeds; (b) decentralizing research budgets and programs to provincial levels so that research can be more responsive to local priorities; (c) developing more efficient alternatives to central seed farms; and (d) exploring the possibility of developing mutual recognition agreements (MRAs) between Indonesia and other countries to streamline quarantine regulations while still safeguarding public health. Under the agreements, Indonesia and its main trading partners (Japan, Australia, United States) would mutually agree to accept each other’s SPS certificates for agricultural commodities exported to or imported from Indonesia. These are important steps in the right direction, but by themselves will not enable Indonesia to achieve its vision of a commercialized seed industry capable of generating a large variety of high-yielding and high-quality seeds at competitive prices. In light of the experiences of Thailand and the United States, the following general principles are suggested for Indonesia: · revise seed industry regulations to emphasize support rather than control of the private seed sector; · strengthen public sector capacities in varietal development for commodities in which the private sector has little interest and investigate the possibility of public funding of seed development for such commodities to private breeders; · facilitate access to its breeder seeds by private contract growers; · assist small and medium-size firms by providing quality control services that are beyond their financial and technical capabilities; · ensure protection for breeders through a PVP Law and for consumers’ right to information through truth-in-labeling; · strengthen the dissemination of agricultural information and support services to smallholders; 71 Measures outside the seed sector are also important. Thus: · adopt overall agricultural policies that promote competition in input and output markets; · where SOEs compete with the private sector in the provision of private goods and services, create a level playing-field with the long term view of withdrawing public sector involvement. Specific recommendations The priority regulation measures (by end of 1999): · Institute more flexible and selective application of regulation, such as voluntary registration of varieties and certification of seeds. Seek guidance from the International Seed Trade Association (ISTA) to ensure seed quality and adopt OECD schemes for certification; · Adopt quarantine and SPS regulations that follow standard rules of the International Plant Protection Convention (IPPC). (Ensure that there is no overlap between IPPC rules and mutual recognition agreements (MRAs); · For the medium term (two to three years): · Review the adequacy of current procedures for registration and certification, and the performance of seed farms; · Develop a plan of action on how to improve the functioning of the regulatory system and institute a system of accountability for its performance. Like other members of the World Trade Organization (WTO), institute and implement a PVP law. · Allow research institutes to sell breeder seeds to the public; · Decentralize research in plant breeding, seed technology, and seed pathology to increase the availability of preferred HYVs; · Standardize seed certification services; · Extend services at cost to small and medium-size producers to raise the quality of their production. 72 References Abrahamsen, M.A. (1976), Cooperative Business Enterprise, McGraw-Hill, New York. 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