AS132

This report was prepared for use within the Bank and its affiliated organizations. Public Disclosure Authorized They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views.

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Public Disclosure Authorized

ECONOMIC DEVELOPMENT OF INDONESIA

(in six volumes)

VOLUME IV

ANNEX 2 - INDUSTRY Public Disclosure Authorized

O ,--* February 12, 1968 0 o

0 0 Public Disclosure Authorized

Asia Department n

CD CURRENCY EQUIVALENTS

Currency Unit - Rupiah

Floating Rate (November 1967)

(1) B. E. Market Rate

U.S.$ 1. 00 = Rp. 150 1 Rupiah = U. S. $ 0. 007 1 Million Rupiahs = U. S. $ 6, 667

(2) Curb Rate

U.S.$ 1. 00 = Rp. 170 1 Rupiah = U.S.$ 0.006 1 Million Rupiahs = U. S. $ 5, 882 This report was prepared by a mission that visited Indonesia from October 17 to November 15, 1967. The members of the mission were:

0. J. McDiarmid Chief of Mission B. K. Abadian Chief Economist Jack Beach Power N. D. Ganjei Fiscal (I.M.F.) D. Juel Planning G. W. Naylor Industry (Consultant) G. J. Novak National accounts J. Parmar Industry R. E. Rowe Agriculture M. Schrenk Industry H. van Helden Transportation E. Levy (part time) Statistics Mrs. N. S. Gatbonton (part time) External Debt Miss G. M. Prefontaine Secretary

Messrs. R. Hablutzel and W. Ladejinsky also contributed to this report.

Since the mission's visit substantial changes have occurred in the effective exchange rate structure and prices have risen at a more rapid rate than during the previous months of 1967. These developments may require reconsidera- tion of the magnitudes in the 1968 budget. However they have not altered the basic conclusions of the mission in respect of the performance and prospects of the economy.

ANNEX 2

INDUSTRY

CONTENTS

Part I

page

Industrial Employment 1 Natural Resources Base 1 Investment Policy 1 Investment Resources 6 State Enterprises 10 Factors Adversely Affecting Costs 13 Tariff and Tax Policy 15 Arrangements for Providing Industrial Finance 18

Part II

Oil Industry 19 Textile Industry 31

Part III

Projects 41 1968 Program 41 Retarded Projects h Five-Year Plan 45 Technical and Managerial Assistance Requirements 50 Program Implementation 52 Management Training 53 Phasing of Work and Planning 54

Appendix 1 - 1968 Program 55

Appendix 2 - Retarded Projects 80

Appendix 3 - Development Finance Companies 99

INDUSTRY

PART I - GENERAL

Industrial Employment

1. The principal branches of industry in Indonesia were outlined in Chapter 6 of the main report. Adequate and up-to-date statistical information on production in specific industries is lacking but the composition of employ- ment by major industrial sectors and by regions in 1964 is shown in Tables 1 through 4. It will be noted that individual establishments were quite small, averaging less than 30 workers and that the concentration of industrial employ- ment on Java and Madura (about 88 percent) was somewhat greater than their share of the total population. About 54 percent of all industrial workers were engaged in the food and textile industries.

Natural Resources Base

2. Indonesia is rich in minerals, petroleum, and some staple agricultural and estate products suitable for industrial processing. Crude oil is produced in large quantities in Sumatra and Kalimantan, with important refining capacity at Palembang and Balikpapan. There is off-shore drilling north of eastern Java and plans for further exploration exist elsewhere. Total production of crude presently is about 27 million metric tons per annum, about a quarter of Iranian output and 5 percent of the whole Middle East; natural gas is available in quantities considerably beyond the capacity of existing processing installations. Mineral products which are mostly exported in the form of ore include tin, nickel, manganese,bauxite, sulphur and phosphate. Deposits which are not yet being exploited but explored include copper in West Irian. Production of the low grade coal declined as a consequence of substitution by petroleum for domestic use. However, projects exist for utilizing the coking coal and iron ore deposits in South Sumatra and Kalimantan for the production of steel. Similarly, a project of long standing which has never been executed is the production of aluminum from domestic bauxite presently exported to Japan, using the large hydro-electric potential of North Sumatra.

Investment Policy

3. Considering Indonesia's natural resources, and also the size of the potential domestic market for products of manufacturing industry, the policy in the recent past has been to promote this sector principally from the raw material base up, by establishing metallurgical industries and, to some extent, heavy chemical industry based on petroleum. However, these large-scale basic industries are a relatively recent endeavour and most of them have not reached fruition. The increasing population pressure on Java-Madura and the general diligence of the labor supply are favorable factors arguing for greater industrialization particularly in import substitution industries. Population can be expected in future to outgrow the absorptive capacity of Javanese agri- culture very substantially. Emigration to the Outer Islands has been attempted SI ³ -- --- . \ ¿ _ ½ ,. ¿ ,. ½

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JAVA & P R 0 V I N C E BALI INDUSTRY MA13UFLA WWT JA VA MID-JAVA EAST JAVA JOGJAKARTA DJAKARTA SUMATRA KALIMANTAN SULAWESI 111USATENGGARA MA LU KU WEST IRIAN TOTAL

FOOD MANUFACTURING 23.2 20.2 19.5 33.4 8.7 5.7 24.7 30.1 28.9 25.6 6.6 14.8 23.5 BEVERAGES .6 .5 .3 .7 .5 1.1 1.0 1.7 1.5 .4 4.3 7.6 0.7 TOBACCO 16.1 .1 21.4 27.5 8.o .1 2.8 - .1 36.1 - - lh.7 TEXTILES 31.2 46.9 42.8 15.8 58.2 19.7 9.2 .1 35.c) 21.8 28.9 01 MANUFACTUREn TEXTILE GOODS 1.5 1.5 .5 .8 1.2 6.3 .2 .5 1.6 .2 .7 1.4 WOOD 1.7 .9 1.0 2.6 1.1 1.6 10.4 15.4 7.0 .7 46.1 14.8 2.7 FJRNITURE .9 .6 .8 1.1 1.4 .8 .9 1.1 1.8 1.3 12.5 - 0.9 PA PER 1.0 .8 .8 1.1 - 2.3 .8 - .1 - - - 1.0 PRINTIWS 2.4 1.9 1.3 1.1 5.7 9.3 2.8 3.7 4.6 1.8 10.5 .9 2.5 LEATHER .5 .4 .2 .5 1.5 1.6 .2 1.9 .1 - - - o.5 RUB3EF 5.3 12.8 3.7 1.5 .1 7.6 28.8 36.9 - 1.4 - - 7.5 CHEMICALS 2.8* 1.6 1.5 3.0 1.4 7.5 5.o .4 3.4 1.1 12.9 - 2.9 NON-KETAL MINERAL 3.8 6.5 2.9 3.8 4.5 5.2 1.8 6.7 4.8 - 9.0 3.9 kiETAL PRODUCTS 2.9 1.8 1.5 2.8 4.1 8.7 1.0 1.2 1.0 1.7 - 2.7 IIANUFACTURE & REPArR-MACHINERT .6 .5 .2 .9 .6 .7 .9 .3 .1 - o.6 4ANUFACWRE & REPAIR-ELECTRICAL

MACHINERY .7 .4 .2 .6 .1 2.7 .5 .2 - - o.6 rRANSPORT BMPMENT 3.7 2.2 1.5 2.5 1.2 16.8 4.8 h." 7.5 .9 - 52.1 3.9 ffISCELLANEOUS 1.1 .5 .5 1.2 2.6 2.9 .6 .2 .4 2.5 7.0 - 1.1 TOTAL 100 100 100 100 100 100 lco 100 100 100 100 IDO 100

40TE: Totals may not add up to exactly 100 due to rounding. ;ource: Central Bureau of Statistics, Industrial Census 1964, Djakarta 1967. Table 3: STRUCTURE OF h&PLOTMENT, BY MAJOR INDUSTRIES, MID 1964

Region: Region: Region: BALI & Region: Region: JAVA & Province: Province: Province: Province: Province: Region: Region: TOTAL IN'DUSIRY SUMATRA KALIMANTAN SALAWESI MUSATEN3GARA MALUKU WEST IRIAN MA DUiA ii. JAVA MID-JAVA EAST JAVA JOGJAKARTA DJAKARTA

1.4 1.7 .9 * * 100 86.8 17.4 17.4 48.7 1.0 2.4 9.1 00f MANUrACTURIN 3.0 3.3 .5 .2 .5 100 79.3 13.9 9.7 37.h 2.2 16.1 13.2 EVERAGES - * 2.1 - - 100 96.2 .2 30.4 64.1 1.6 .1 1.7 100 OBACCO 5.7 6.6 2.8 * 1.7 .6 - - EXTILES 94.9 32.8 30.9 18.8

.L 1.7 .1 - * 100 21.4 7.6 21.1 2.4 4h.0 1.2 ANUFACTURED TEXTIL GOODS 96.5 3.7 .1 .4 .2 100 7.0 7.8 33.5 1.2 5.7 33.9 6.6 10o 55.0 1.2 .4 - 100 85.5 13.9 17.0 41.2 4.3 9.0 8.8 1.3 2.8 "URNITURE .1 - - - 100 APER 93.2 15.4 16.0 39.6 - 22.2 6.7 -

.6 .1 * 100 15.5 11.2 15.5 6.6 36.5 9.7 1.7 2.6 PIrNTIm 85.2 - - 100 14.4 9.6 30.7 8.0 28.8 4.1 i.1 .3 - .ATHER 91.5 - - - 100 61.3 34.5 lo.4 6.7 * 9.7 33.0 5.5 !UBBER 1.4 24.8 14.8 .1 1.6 .3 .1 - 100 'HEMICALS 83.0 11.3 10.9 34.5 .1 100 11.1 11.4 .5 2.4 1.0 - MINERAL 84.6 33.6 11.5 25.6 2.7 ION-METAL 4.3 30.8 3.1 .5 .5 .5 - - 100 fETAL PRODUCTS 95.3 13.1 11.9 35.3

- 100 2.6 11.2 13. .6 .3 - - 1ANUFACTURE & REPAIRIN-MACHINERT 85.7 17.8 5.4 48.8 100 .3 40.5 6.9 * .3 - - - (ANUFACTURE & REPAIR-EILECTRICAL MACHINERT 92.7 11.8 7.2 32.9 OF TRASPORTATION qAWUFACTURE 8 41.6 10.7 1.4 2.7 .2 - .6 100 4.4 11.5 8.1 22.3 .9 100 EwIPIaT 7.0 26.2 5.2 .2 .5 2.0 .2 - IISCEILANEOUS 92.0 9.5 10.1 39.2

9.6 8.6 1.1 1.4 0.9 * * 100 TOTAL 87.8 20.2 20.9 34.3 2.8

iOTE: Totals may not add up to exactly 100 due to rounding.

* Less than 0.1 %

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а = ¸, ¹ $ З <. _ ³i s - 6 - but not with much success. The country is faced with the problem of concealed unemployment, not only in agriculture but in most industrial and mining enterprises, as well as in government services. The logical conclusion is that Indonesia has both a comparative advantage and an immediate need to pursue a policy of investment in labor intensive industries. However, public investment undertaken in recent years has been relatively capital intensive.

4. The announced policy of the present Administration is to give priority within manufacturing to those industries that either serve agriculture by providing fertilizer, other chemicals,, implements, and mechanical equipment, or utilize the produce of agriculture as raw materials., mainly in food and fiber-processing industries but also those utilizing estate proctucts such as rubber and palm oil. This apparently is in contrast to the "basic industry" approach of the preceding government. An exception will be the heavy industry projects already started, which are presently suspended., and. where a systematic review may lead to their resumption on the grounds of large resources already invested which may otherwise be lost. Future action with respect to these projects is considered in Part 3 of this Annex.

5. There are of course specific industries where the Governmentts general investment policy will not be subject to significant change, as in the case of the textile industry where new investment in spiiming capacity will undoubtedly be continued because of the obvious need for a better balance with weaving capacity, or in the case of cement where there is no doubt about the n--ed as well as theeconomic justification for further import substitution.

Investment Resources

6. Private domestic capital for investment in industry is scarce. During the era when the concept of the State-guided economy was applied and all large- scale industrial and mining enterprises were nationalized, private capital formation was limited to corporate savings in the remaining private commercial enterprises, in small-scale industry, and household savings. As a result, private capital today is insignificant in volume for a country the size of Indonesia. Furthermore, a good part of commercial capital is subject to special constraints, at least for the time being, from the fact that it is in the hands of Chinese nationals. Therefore, it is unlikely to be forthcoming or welcomed as long-term industrial risk capital unless a clear-cut policy of support for such investment is established by the Government.

7. With the return to the principles of the market economy and realiz- ing the damage done in the period of nationalization, the Governmentsince 1966,entered into negotiations for the return of industrial enterprises, formerly foreign-ouned, to their previous owners, and enacted a new foreign investment law offering the usual incentives available in other developing countries to private foreign capital. A similar law for domestic investment is now under consideration. The important features of both of these laws are discussed below. 8. With the exception of former Dutch enterprises falling under the compensation agreement, it has been the endeavor of the Government to enter into individual transf r agreements, returning assets and management control to the former owners ' While these companies do not appear to fall under the new investment law except for new investment undertaken by them for expansion and modernization, they will benefit from at least part of its advantages to be negotiated in each agreement.

9. In some of these cases the Government has been successful in obtaining,as a quid pro quo, assurances by the foreign companies concerned regarding new investments to be undertaken by them in the next few years for expansion or rehabilitation. For example, the Good Year Company re- portedly is to invest $13 million in the next four years, leading to a doubling of the capacity of the existing plant. The agreement with Unilever provided for a $1 million rehabilitation program, new investment of $0.5 million in new products like detergents, and an unspecified amount for ex- pansion and modernization of its distribution system.

10. The new Foreign Investment Law was enacted on January 10, 1967, providing for tax incentives, transfer guarantees, land use, and arbitration of disputes in the event of nationalization. These provisions are summar- ized in the following paragraphs.

11. The fields open for private foreign investment cover most business activities except production for national defense, and certain limitations are stipulated on "full control" in those fields which vitally affect the public interest such as harbors, electric power, communications, shipping, aviation and railways. However, the Government has considerable freedom of action in the interpretation of this clause, as demonstrated by the recent agreement with IT&T for the construction of a ground station for INTELSAT communication satellites. The Government has also established the rule that for investments of less than $2.5 million, local equity participation is required in order to obtain the benefits of the foreign investment law.

1/ As of July 1967, transfer agreements had been conducted already for most of the more important enterprises falling under this policy, as follows:

Good Year Tire Factory, Bogor Heineken Beer Factory, Djakarta Archa Cooking Oil Factory, Djakarta Unilever Soap and Margarine Factory, Djakarta Fileo Cooking Oil Factory, Surabaja Colibri Soap Factory, Surabaja Prodenta Tooth Paste Factory, Surabaja Eveready Battery Plant, Djakarta Bata Shoe Factories, Djakarta and Medan Naspro Factory, Djakarta 4 BAT-owmed Cigarette Factories, Tjirabon, Semarang, Surabaja, and Malang 2 Fraser and Neave Soft Drink Plants, Djakarta and Surabaja. - 8 -

12. The law offers exemptions from the corporation tax and the tax on dividends up to five years; exemption from import duties for capital equip- ment imported for the enterprise and from the capital stamp tax; reduction in the rates of corporation tax for an additional period up to five years; offsetting of losses, incurred in the first period, during the second period; and accelerated depreciation. As part of these provisions are not very speci- fic, the Government uses its own discretion from case to case. However, the tax holidays have been further defined in Instruction No. 6 of 1967, where a basic tax holiday of two years is set for all investments of at least $2.5 million, wholly foreign, or below that minimum if there is Indonesian parti- cipation. Another year is granted to investments which save or increase foreign exchange earnings, plus another year for investments outside of Java, and individual cases in Java, implying high risk or a specially large amount of investment. Finally, "pioneer investments" made before the end of 1968 obtain another year of tax holiday. Since it would seem difficult at this stage to make a large investment without saving or increasing foreign ex- change, a five-year holiday for large investments made before the end of 1968 would seem assured.

13. The law gives the right of transfer of capital in the original currency at the then current exchange rate for profits after tax, deprecia- tion, and compensation in the event of nationalization, as well as income of expatriate staff, and other unspecified "costs". Subsequent policy direc- tives specify the latter to include the proceeds of the sale of original foreign stock to Indonesian nationals, and interest and principal on foreign debt. Loan capital does not, however, benefit from tax exemptions.

14. Foreign capital enterprises are given the right to use, occupy and exploit land under Indonesian laws. Companies are to form legal entities under Indonesian law and be domiciled in Indonesia except where the company's principal activities are international and its headquarters is abroad.

15. The law states that the Government will not carry out comprehensive nationalization of foreign capital enterprises nor will it take steps to interfere with control and management of these enterprises, except if such a step is declared by law to be in the interest of the State. In the event of such a step, compensation will be given as agreed by the parties concerned, and in the absence of such agreement, by arbitration which is to be binding and final, through an arbitration committee of three persons, where two would be chosen by each party and the chairman selected jointly..! The Government is presently studying the possibility of joining the IBRD sponsored International Center for the Settlement of Investment Disputes.

16. Fields of New Foreign Investment. Indonesia's natural wealth and her potential for future growth are obvious factors attracting foreign invest- ment. The present outlook for relative political stability, the pragmatic approach to economic policy by the present government, the passing of the new investment law, and in the case of U.S. investors the AID guarantee agreement, are more recent factors that have unleashed these interests after a long period of dormancy.

17 New investors are invited to propose more specific machinery for the selection of the third arbitrator for inclusion in contracts or for general use, e.g., selection by an international institution. 17. One of the first contracts of considerable importance was concluded in the summer of 1967 for the exploration and exploitation of copper in West Irian by Freeport Sulphur Company. The contract pro- vides for $1.5 - $2 million investment in exploration and possible sub- sequent investment in mining up to $75 million. Another contract, already mentioned, was with IT&T for a ground station, involving an IT&T investment of $6.2 million. Some small Japanese ventures are forthcoming in the fields of fishery and shrimping.

18. In the field of banking, seven or more foreign banks have submitted proposals and special legislation has been enacted. Much interest is shown in petroleum exploration; concessions were issued in 1966 to Japanese and other foreign companies. Investment is expected in the near future in pharmaceuticals, asphalt production, fish processing, timber and other industries.

19. Besides copper, other fields of mining are very important for for- eign investment. The tin mines formerly managed by the Dutch, etc. will remain Indonesian, but U.S., French, Japanese and Canadian firms are inter- ested in the development of new mines and possibly participating in the re- habilitation of the existing mines in some form or other. Good prospects exist for foreign investment in nickel in Sulawesi by Japanese, French and American firms. 20. On January 7, 1967, Indonesia signed a bilateral agreement with the United States whereby the latter offers insurance to its nationals against nationalization, currency inconvertibility, war and other disturbances. Similar agreements are hoped to be concluded with other countries, but none has been reported so far.

20a. Private Domestic Investment. In order to mobilize domestic savings and to stop or to reverse its suspected outflow, a Domestic Capital Investment Law is also under preparation. Although it applies to all kinds of "domestic capital," state, private national or private foreign (owned by foreigners, domiciled in Indonesia) it is actually geared to this last category, the so-called "foreign domestic capital". This is mainly capital of the well-to-do Chinese minority group which has not acquired Indonesian citizenship. With respect to the citizenship of the owners, the law distinguishes between "national enterprises" (with a minimum of 40 percent domestic capital) and "foreign enterprises" which do not meet the definition of national enterprises.

21. This distinction is important as the proposed law stipulatesdefi- nite time limits for "foreign enterprises", namely 1977 for the field of trade and 1997 for the field of industry. After these dates, foreign capital has to be transferred to Indonesian citizens, or the enterprise has to be changed to a "national enterprise" (as defined above), otherwise it will be taken over by the Government. Another limitation is the explicit exclusion of any joint ventures between foreign domestic capital and foreign capital. - 10 -

22. The benefits provided for by the Domestic Capital Investment Law are in principle similar to those of the Foreign Investment Law. Major differences are that the law does not contain any provision for nationali- zation and compensation if nationalization should occur, and a "national" enterprise cannot be changed into a "foreign" enterprise.

23. Control of the operations of private sector enterprises appears to be confined mostly to licensing of new enterprises. The ministries exerting this control are guided by the goal to avoid excess capacity and menacing competition to existing state enterprises. Another area of control is the regulation excluding dismissal of labor force. Applications from the private sector enterprises for the reduction of staff appear to be treated more generously than those of state enterprises if compensation is granted to the dismissed staff.

State Enterprises

24. Industrial statistics do not provide a breakdown as between the public and private sectors. From the fragmentary information collected by the mission, it would seem that a maximum of 30 percent of total in- dustrial workers and 50 percent of those in establishments of 50 workers or more are employed by state enterprises. Indonesia has adopted the policy of making industrial state enterprises autonomous. Implementing it, however, is likely to be a most difficult task.

25. The past system, under which practically any operative decision, both short and long-run, was handed down from the supervisory ministries, left the managements of the plants in the position of being administrative outposts of the ministries. This has been modified during the last two years in the direction of giving the managers more decision-making powers. At present, the managers are responsible for most of the short-run decisions such as level and composition of output, sales prices and marketing, procure- ment of current inputs and applications for short-term credits. The major restriction on short-run decision-making concerns recruitment and dismissal of the labor force. Any appointment in the higher ranks is decided by the responsible ministry and dismissal of surplus labor has to be approved by the Department of Labor, which tends to turn down applications for social reasons.

26. Any decision respecting investment in or expansion of existing state enterprises is still taken by the ministries. As to new state enter- prises, both the decision-making and the administration is carried out by the ministries until the plants become fully operative. This leaves the ministries with a heavy load of day-to-day duties, and prevents the manage- ment from developing skills and responsibilities for long-range planning.

27. The state enterprises that are under the supervision of regional governments are controlled and guided in principle by a similar system. Its actual operation, however, seems to vary depending on the competence of both parties concerned and on the financial strength of the state enterprise in question. - 11 -

28. The difficulty of moving towards greater autonomy for the enter- prises does not lie so much in convincing the ministries to divest them- selves of responsibilities or in the problem of what to do with persons in the ministries who have been administering them, but it lies in creating the conditions under which the state enterprises can successfully operate autonomously.

29. The following are some of the steps that must be taken if the Government's avowed policy is to be carried out:

1) The rights of the Government as a shareholder vis-a-vis those of the directors who are to run the companies must be carefully delineated. Capable Boards will have to be organized. The same care should be given to this as would be given to setting up the management for a large privately organized company.

2) At present, company administrators are career civil servants or they are in the military and consider their positions with the state enterprises as temporary. Managers of the autono- mous companies must consider that job as their career and feel first responsibility to the Board rather than to some outside authority. The managements of most of the companies are weak, although there are exceptions. The Government may have difficulty in inducing capable persons in its service to switch over to these companies. The shortage of good managers will be a problem, and removing ineffective managers currently in those companies will be a further problem. Thus, many of the companies need technical and managerial assist- ance if they are to survive. Arrangements will have to be made to provide them with this help.

3) Before some of the companies can achieve efficient operations, they may need additional equipment for balancing or replace- ment. Arrangements must be made for the additional funds to be made available. Also, most of the state enterprises are acutely short of working capital. They rely on the Bank Negara Indonesia for credit whether or not they have the capa- city to repay. Once really autonomous, they cannot expect .this kind of support and therefore they must have sufficient permanent working capital to operate at a capacity which allows them to realize a profit which will augment their work- ing capital. Without this initial working capital, these companies cannot survive.

4) It is important that all financial relationships with the Government be on a well-defined contractual basis. Most of the companies have substantial government advances but it is not clear whether these advances will be transformed into equity or into debt, and if into debt, on what terms. The debt/equity ratio should not be so high as to threaten the solvency of the enterprise, especially during their early years when they will be expected to operate without subsidies. - 12 -

5) The Government must review the tax burden it is imposing on these companies because in due course many of them should be able to show a profit and, contrary to the past, will have to pay taxes. In this connection, it is important that revaluation of assets be permitted so that reasonable depreciation is allowed and the companies are not taxed on artificially inflated profits. It is important that these companies formalize their arrangements for power, water, contracts for sale, etc., so that the management can estimate its future costs and revenues accurately.

30. After the various measures have been taken, it will become clear whether the companies will be able to face competition from imports at the existing levels of import duties. If they cannot face this competition, then measures must be taken to expand the project if the problem lies in economies of scale, improve marketing, improve quality, etc., to bring them to a position where they can compete.

31. Once autonomous, there must be a financial institution which can provide both long-term financing for capital goods acquisitions as well as short-term credit to finance expanding working capital needs. This insti- tution would have to be developed concurrently with the process of creating favorable conditions under which the state companies can manage their own affairs.

32. The work involved in reviewing each company by turn and deciding on the necessary measures is enormous and the Government should not take short-cuts in carrying out this task. It is entirely possible that the Government may not have the capability to make these studies and may re- quire expert help. Naturally not all conditions to make these companies independent can be fulfilled quickly. There will be a transition period with the companies receiving different levels of support for varying periods of time.

33. The Government has already foreseen the necessity for a consolida- tion of some of the state companies operating in the metal working field and is presently prepared to offer all of them for individual or joint purchase and operation by foreign investors.

34. Because of the size, diversity and present difficulties of these operations, the possibility of early interest by many foreign investors appears remote. The mission, therefore, recommends that a plan be prepared to achieve the maximum contribution by these companies to the industrial growth of Indonesia. It should make full use of the equipment presently installed. It is recommended that the specialized assistance required be obtained and the study carried out promptly.

35. There may be other instances where the consolidation of existing enterprises at the production, procurement or marketing level would produce substantial economies. The mission did not have the opportunity of explor- ing this subject and recommends that it be part of the plant-by-plant review suggested above. - 13 -

Factors Adversely Affecting Costs

36. Scale of Production. Industries in Indonesia which are now operating at close to their rated capacities are comparatively rare so that it is difficult to conclude as a general proposition that more efficient production could have been achieved by building larger units. However, there are some examples mainly in the heavy chemical field (cement and fertilizer), in paper production and in the weaving branch of the textile industry, where expansion schemes now contemplated should increase operating efficiency and thus reduce capital/output and labor/output ratios.

37. The Gresik cement factory, regarded as the most modern cement unit in Indonesia, has kilns of 120,000 tons annual capacity. In comparison, a recently erected cement factory in Malaysia operates kilns of 200,000 ton capacity. Another example is the Pusri fertilizer plant. Its capacity of 100,000 tons of urea per year compares with an international standard of at least 300,000 tons per year. Indonesian paper mills are generally of a size far below international standards.. In the oil refinery industry, the Indonesian refineries are of substandard size due to their age.

38. Scale of capacity appears to have been tailored in some instances to availability of credits rather than any other consideration. In any future planning this problem certainly deserves more careful consideration. Improved transport and reduced transport costs must of course go hand-in-hand with greater concentration of production.

39. Power Charges. Practically all industrial enterprises are generating their own electric power. This applies to activities of every size or consumption pattern from big consumers with a constant demand load, such as a sodium chloride electrolysis plant, to small units such as weaving mills, which are run by a truck engine in the backyard. The reasons given are (a) industry "cannot afford" to buy electric power from public utility power stations,and (b) electric power delivery is insecure. At least the first poiht seems well taken. Industry is charged about 4 times the price the residential consumer has to pay, with a prohibi ive extra charge for peak hour consumption (about 3 - 4 hours per day).1 This pattern is the reverse of what one would expect from the economic point of view. This is apparently another instance of an attempt to subsidize domestic consumption in a way that cannot be effective since ultimately the subsidy gets reflected in higher prices of the goods produced, less employment and lower real income. The effect is`that most of industry has switched to its own power generation.

1/ The rate structure in middle of 1967 can be summarized as follows: Fixed Charge Running Charge General Industrial Tariff Rp. 75 for per Kwh, up to 100 hrs month, every 500 VA outside peak hours Rp. 3.20 per Kwh, above 100 hrs month, outside peak hrs. Rp. 4.60 per Kwh, within peak brs. Rp.12.50 Residential Tariff (below Rp. 1.50 for per Kwh, up to 200 hrs month Rp. 0.80 2500 VA) every 25 VA per Kwh, above 200 hrs month Rp. 8.00 Domestic Tariff (above Rp. 2.25 for per Kwh, up to 200 hrs. month Rp. 1.10 2500 VA) every 25 VA 1per Kwh, above 200 hrs month Rp.11.00 - lh -

4O. The perpetuation of the present rate structure has the additional disadvantage of making any future correction more and more difficult. Potential industrial customers with heavy power consumption, which could contribute to making public utility power stations more eccnomical by providing a constant basic load, are definitely lost for this purpose once they have decided to install their own generating units.

41. It is recommended that the Ministry of Basic Light Industry and Power undertake to establish a reasonable rate structure for the supply of power to industry against which central power station investments can be made and the installation of self-contained plants at industrial sites reduced. Specialized assistance in this connection may be required for a brief period and would certainly be recommended.

42. Transport Costs. The reasons for the relatively higher costs of transportation in Indonesia are discussed in Annex 3. The widely dispersed nature of the economy is, of course, a permanent factor, though the concentration of people and industry on Java and the lower unit cost of water transport should be offsetting considerations.

43. The effects hit industrial activity more, the lower the value per unit (weight or volume) of plant input or output. This would result in a growing lack of competitiveness of Indonesian production as compared to imports, beyond the immediate vicinity of the manufacturing site, even if manufacturing costs were competitive. It affects long-distance deliveries in Java, and to a much greater degree, deliveries between the islands. For that reason, Indonesia can hardly be regarded as a "national market" for certain voluminous heavy low-cost commodities, e.g. cement. No acceptable import duty levels could make domestic commodities competitive beyond a certain distance from the plant.

4h. Another effect of the high cost of transportation is that the optimal plant sizes, which are based on both costs of manufacturing and costs of transportation, tend to be smaller in Indonesia than in other countries. This leads to uneconomic plant sizes in those industries in which economies of scale are important.

45. It is hoped that by better management and some capital investment some economies can be effected in water and rail transportation so that more appropriate rates can be established. Some of the industries involved will probably have to absorb some of the transportation costs as is done in other countries if a wider geographical market is to be supplied from a given plant, but all of the burden cannot be carried by the industries themselves.

46. Labor Costs. In the past, social considerations led to redundancy of the labor force in most state and some private enterprises. Since the wage bill could not be adjusted to output, labor costs came to resemble fixed charges. However, this rigidity has been reduced somewhat by actual practice in making wage payments. - 15 -

7. Actual wages can be broken down into three major components: base payment, performance benefits, and special allowances. The base payment in the public sector is fixed by government regulations according to level of edu- cation, skill and position, age, and family size; it is adjusted from time to time to inflation, though insufficiently to maintain its real value. The per- formance benefits are paid according to position of the wage earner in the company and to its overall performance; the state enterprises have a consider- able degree of freedom in its determination. The special allowances, which have become by far the most important element in real wages, consist of fixed amounts for rent and non-food commodities and rice according to the family size. The rice allowances is paid in kind, or in cash according to the average rice price for the wage period. The relative weight of the last component and the increasing rice prices ntroduces a variable cost element into the total labor bill which may push up its growth rate above that of the prices of the plant's products.

48. As a consequence of this system, wage differentials as between diff@rent grades of labor and, in fact between labor and management have been greatly reduced. The actual pattern is illustrated by the breakdown of the wage of an unskilled worker, married, with one child, in October 1967; the basic data were obtained from a state enterprise, the wage level and policy of which was described as being "typical":

Base payment 0.3% Performance benefit 42 % Fixed allowances 14 % Rice allowance (paid in cash) 43 %

A 100 percent increase of the price of rice would increase the wage about 45 percent. The managing director, assuming the same family size, would get only roughly double the payment of an unskilled worker; only the base payment would increase substantially, accounting for about 36 percent of his salary. A single managing director, however, would have about the same total salary as a married unskilled worker. In other words, the present system leaves little room for any incentives to the managerial personnel.

Tariff and Tax Policy

49. Duties. The revenue orientation of the customs tariff has thus far precluded its use as a very effective protective device. With the removal of quantitative restrictions and the increase in foreign commodity aid, domestic industry has been exposed to increasingly severe competition despite the depreciation of the exchange rate.

50. The mission did not reach any definite conclusions in respect of all the types of industry which may have a comparative advantage in the long-run, but, as pointed out in the main report, these would seem to be a prima facie case for giving careful consideration to this problem. At present the matter seems to be within the discretion of the Minister of Finance. - 16 -

51. It is recommended that to consider (inter alia) import duties and surcharge problems, a committee be established on which the appropriate and interested agencies would have representation, such as the Finance Ministry, Bappenas, the Ministry of Basic, Light Industry and Power and other interested ministries.

52. The import tariff itself seems on the whole to be reasonably struc- tured but there is little doubt that many individual items carry too low a duty because they used to be imported on government account. Together with surcharges, import taxes now range from zero to about 200 percent, with non- luxuries up to 55 percent. Ostensibly, through the July 1967 readjustment of import surcharges the Government has somewhat increased the cost of imported goods which are competing with domestic industries, but this must be considered a side effect rather than a principal objective; the effect was mostly limited to luxury goods and no change was made in duty rates with a view to increasing protection to domestic value added.

53. Taxes. Another function of the committee suggested in the same previous paragraph might be to see that internal taxes and duties on imported components and materials are properly adjusted to the duties on the imported finished goods (or vice-versa) so that the desired level of net protection is provided to domestic industries. The complrxity of the present system (described in Chapter 3 of the main report) of tariffs, surcharges and internal taxes makes it very difficult to calculate just what amount of net protection (based on domestic value added) is being afforded.

5h. In respect of direct taxes, the mission was impressed with how small a portion of an enterprise's net earnings it is allowed to retain. The maximum level of the corporation tax is 60 percent,and in addition state enterprises pay 55 percent of their after-tax net income to the National Development Fund as a sort of dividend. These requirements are academic in most cases at present. However, in the future the profitable state enterprises may need to retain a larger portion of their net earnings for healthy expansion. Also net income is figured without allowing for proper depreciation.

55. The assets of Indonesian companies are carried at their rupiah historical costs which are far below their rupiah replacement costs because of the depreciation of the currency through high inflation rates prevailing during the current and past several years. Consequently, depreciation based on historical cost is much less than that necessary to replace the assets. Profit subject to tax therefore is inflated and income tax must be paid on that portion of the inflated profits which would have represented additional depreciation had assets been valued on a replacement-cost basis. Similarly companies could pay dividends out of these inflated profits, which would be tantamount to pay- ing out capital. The Indonesian Government recently allowed a revaluation of fixed assets by 20 times but this is insufficient in comparison to the infla- tion which has taken place. - 17 -

56. One can conclude that "profit" and "loss" on that basis are approxi- mately equal to the differences between gross revenues and current expenditures. Fortunately, the liberal application of the regulations reduces the worst effects on the taxation of profitable enterprises, which are - as one would expect - highly capital-intensive ones.

57. The Government's t x policy has to be seen in conjunction with its subsidy policy of the past.!/ As far as the latter was designed to benefit industry, it included, besides fixed low rates of transport, electricity and other utilities, and a low exchange rate for imports of most government enterprises.2/ The latter was very important since, before October 1966, these imports were priced into the economy at about one-tenth of the BE rate of foreign exchange. This was in effect a subsidy to government importF which was charged to the export sector through the requirement of partial surrender of export proceeds at the same nominal exchange rate of Rp. 10 per U. S. dollar.

58. At the same time, indirect taxes on industrial inputs and outputs were and still are considerable. For example, most domestic raw materials carry 10 - 20 percent sales tax (e.g. 20 percent on domestic palm oil used in the soap industry). Three to four different taxes are levied on the finished goods. State enterprises pay a 2 - 3 percent fee to the central office of state enterprises, and regional governments charge a levy of 10 pei,cent on most manufactured goods., In addition, central excise duties range between 20 and 50 percent, and the sales tax adds another 5-50 percent.l/ The latter two have to be prepaid when the goods leave the factory and therefore have to be financed before the distributors make their payments. Such financing at present costs 9 - 10 percent per month. These various charges appear very high - al- though of course the highest rates of tax apply to luxury goods and this would appear sound - and they are probably an important indirect cause of insolvency for many Enterprises at present,, since most subsidies to state enterprises have been abolished.

Operating Targets for State Corporations

59. It would be useful to establish the goals which the state corporations are expected to achieve with respect to profitability, dividend rate, scope and projected size of operations, and level of reinvestment of earnings per- mitted. Such a clarification would not only guide the managements but also bring the operation and performance into consonance with long-term developments.

60. Corporations should be urged to strengthen their marketing staff since all have surplus capacity and would benefit from a clearer understanding of market needs and desires. Indeed marketing skills will need to be increased and improved throughout the industrial fabric as additional productive capacity is added.

1/ More investigation would be needed to evaluate past subsidy policy with regard to cheap credit, specific utility rates, and possibly also fiscal privileges to specific sectors. 2/ The mission is informed that there was no overt discrimination between public and private enterprises in this regard. 3/ In Indonesia the effect of the sales tax is accentuated since it applies to gross value of output rather than value added. . 18 -

Arrangements for.Providing Industrial Finance

61. The Government has asked for help from the World Bank Group in establishing a development finance institution. During this mission's visit to Indonesia, a preliminary review was made of existing institutions and a first attempt was made at assessing the needs for such an institu- tion. Our observations on this subject are in Appendix 1 to this Annex. Our principal conclusions on this and related subjects are as follows:

(a) Indonesia has need for help in establishing government bodies to perform the functions necessary to accelerate industrialization. The public sector is likely to con- tinue to play an important role in industrialization, therefore, it is important that experts be found who *are familiar.with the organization needed under such a system.

(b) Concurrently with the workon the overall organization, the Bank/IFC might initiate studies aimed at determining the institutional framework needed for providing long- *term financing to. Indonesian industry. The starting point would be to study the existing institutions to determine if any one of them can provide the basis for the proposed new institution. This study would also show the role the regional development banks should play, how they should be modified and if they are to play an important role, particularly in financing small industry, how they should be strengthened.

(c) Indonesia will be receiving project aid in 1968 from its creditor countries, which, together with budgetary funds, must be used efficiently for industrial and other projects. The present system for allocating, disbursing and control- ling funds for industrial projects is not effective. A qualified person is needed to help Indonesia in developing efficient procedures for administering these funds.

(d) Until the new institution mentioned in (b) is formed, private industry will have no source of long-term financing or means of obtaining guarantees for foreign credits. Consequently, arrangements might be considered, perhaps by the Central Bank, for guaranteeing long-term credits on favorable terms to.-the private sector. Similarly, arrange- ments should be made to relend a part of the foreign project aid to the private sector. The person advising on the administration of funds could also advise on a system for relending foreign project aid to private industry. PART II - INDIVIDUAL INDUSTY STUDILE S

OIL INDUSTRY

62. Production. Although the share of the oil industry in Indonesia's national product is probably not more than 4-5 percent, its contribution to the balance of payments both in terms of direct foreign exchange earnings and in terms of import substitution is substantial.

63. In 1967 the gross exports of the oil sector are estimated at $244 million or 32 percent of total exports and the foreign exchange value of domestically consumed refinery products may be about $60 million. The latter figure is a considerable understatement of the real value of domestic consumption, however, because of the artificially low prices at which it is sold. If the f.o.b. export price were used to price these products, the value of refined products consumed in Indonesia would probably be in the order of $100 million. On the other hand, the net foreign exchange earnings (including lubricants imported by the state oil companies) of the oil sector in 1967 was comparatively small, probably about $70 million. If we add to this the value of domestically consumed refined products, we have a total of $170 million or about one-third of non-oil exports. This proportion is expected to increase substantially in 1968.

64. Table 1 shows the production of crude oil and its utilization over the fourteen years ending in 1966. The decline in the rate of growth of the industry during the last six years is apparent, a trend that is expected to be reversed at least through 1970.

65. The average annual rate of expansion of crude production has been 7.6 percent a year since 1953; 10.5 percent between 1953 and 1960 and only 4.5 percent during the last six years. Since the throughput of the six refinery units in Indonesia has been static (or declining a little in recent years) exports of crude have increased at a faster rate than crude produc- tion, namely by 16.8 percent since 1953. From 1953 to 1960 crude exports rose 24 percent a year and from 1960 to 1966 by 8.4 percent a year. Domestic deliveries of refinery products (by weight) increased on average by 5.3 percent a year from 1953 through 1964.

66. The past rate of growth of production was seriously hampered because (a) most areas except those of Caltex were opened up before World War II and are gradually approaching exhaustion, and (b) exploitation lagged during the last decade due to apprehension about future relation- ships between the Government and the foreign companies. However, recent investments and the situation in the Middle East give promise of producing substantial expansion during the next few years. No up-to-date estimates of aggregate proven reserves appear to be available.

67. The present pattern of deliveries (for 1966) is indicated in Table 1. Fifty- six percent of the crude produced was exported and 44 per- cent processed in local refineries. Sixty-five percent of the total crude production originated from the Caltex area, 12 percent from the Stanvac areas, and the rest from several areas operated by State Companies. Caltex is more export-oriented thah the other companies having no refinery in Indonesia. Table 1

Production and Distribution of Crude Oil and Refinery Output

1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 Production of Crude Oil 000 metric tons 10261 10813 11818 12820 15559 16310 18721 20606 21287 22747 22231 26851 27955 26778

Deliveries of Crude 0 to domestic refineries 000 metric tons 7937 8409 8420 8109 8048 8328 9852 9748 9459 10124 9031 9123 10018 9210

Exports of Crude Oil2/ 000 metric tons 2324 2604 3398 4711 7511 7982 8869 10858 11828 12623 13200 17728 17937 17568

Output of refineries 000 metric tons 10190 10412 10880 1084 11535 10811 11807 11714 11888 11500 9724 8392 9498 8671 Domestic deliveries of refinery producte23 000 metric tons 2501 2794 4365 3030 4207 3355 3838 5200 6129 4951 3954 4392 - - 0 Exports of refinery products 000 metric tons 7689 7618 6515 7814 7328 7446 7969 6514 5759 6549 5770 3615 4h24 n.a.

1/ Refineries were using some imported feed up till 1963; cf. Table 3.

2/ Residual of production and deliveries to domestic refineries; thus changes of stocks are included.

3/ Residual of output of refineries and exports of refinery products; thus changes of stocks are included.

Sources: Central Bureau of Statistics Directcrate General of Oil and Gas Bulletin of Indonesian Economic Studies, Canberra, No. 6, pp. 68, 69 - 21 -

68. The-following was the country distribution of crude oil exports for 1966. All went to destinations East of Suez and to the U.S.A.

Table 2

Company - Country of Destination . Quantity (million bb/s) State Companies Japan 9.8

Caltex/Stanvac Philippines 11.3

Japan 30.6

Australia, 29.0 New Zealand

U. S. A. 1_.5

Total: 95.2

Source: Directorate General of Oil and Gas.

69. Most Indonesian crudes are higher priced premium crudes in the world market due to their high gravity and very low sulfur properties. Some of them do cause additional costs in handling due to high pour points. Production costs are increased due to the remoteness of the fields which are located in very inhoupitable terrain, to high operating costs in maintaining roads and equipment affected by abnormal corrosion and jungle growth and to difficult transportation out to loading points. Wells are shallow in Central Sumatra and deep in South Sumatra. No off-shore production exists at present.

70., Organizational Framework. The petroleum sector is operated under the supervision of the Directorate General of Oil and Gas in the Ministry of Mining.1/ Two state enterprises work under the supervision of the Directoratu, namely Pertamin and Permina. The former concentrates on the supply of the local market, the latter is involved in exploration, producing, refining, sea transportation, and exporting. Permina runs the former installations of Shell which were taken over (by purchase) in 1965; Shell continues to supply technical assitance, and participates in international marketing. Crude oil operations, by area and volume, are described in Table 3.

Under Petroleum Law L1 of 1960, the Government retains control of all oil and gas resources. - 22 -

71. In addition, two foreign companies are producing in Indonesia: P.T. Caltex Pacific Indonesia (under contract with Pertamin) and Stanvac (under contract with Permina). Some new areas, mostly off-shore, have been assigned to other companies, and exploration is at an early stage over a broad area. If recoverable reserves are struck, exploitation would likely take place under a production sharing contract with Permina.

72. Arrangements with the Foreign Companies. The principal differ- ences between arrangements in Indonesia and those in the Middle East are (a) actual realization rather than posted price is used as the basis for taxation (profit sharing), and (b) the foreign company has a "contract of work" with the state enterprise rather than the more autonomous concession- aire arrangements of the Middle East.

73. The system has been altered in the case of the new explorations. A "production sharing" contract is used for the new fields. The principal difference appears to be that, under the new arrangements, the formal management responsibility will rest with the state enterprises,whereas under the Tokyo Agreement of 1963 (which governs the Caltex and Stanvac arrangements), it rests with the foreign companies.

The main elements in the present arrangements are as follows:

(a) The companies have the full operational responsibility for the assigned areas and installations, including transportation and exports of their share of crude.

(b) The accounting of the companies is in U.S. dollars. For all transactions involving local currency expenditures or receipts, a special exchange rate is applied, which at present is 85:1.

(c) The companies pay 60 percent of their net operating income in foreign exchange to the state enterprises, to be transferred to the Government.

(d) The companies deliver crude to the State Enterprises on a cost plus fee basis up to a maximum of 25 percent of their production.

(e) Stanvac refines crude oil in its refinery for the state enter- prises on a cost plus fee basis (Caltex has no refinery).

74. The foreign companies, starting exploration, are to receive up to a maximum of 40 percent of the crude to cover their costs of exploitation, development and production. The other 60 percent of the crude is to be divided 35 percent to the companies and 65 percent to the Government. The Government appears to consider this latter arrangement a little more favor- able to it than the former. Table 3

Structure of Output and Distribution of Crude Oil, 1966

(in mill. bbls)

R E F I K-E R I E S

P. N. PERMINA Oil producing wono- Uik- Institute of P.T. STANVAC Total Area Branden Pladju Kromo papan Petroleum Sungai Gerong Export Output

1. PERMINA, Unit I North Sumatra 0.4 8.7 9.1

2. PERMINA, Unit II South Sumatra 16.9 0.2 17.1 (S. Sumatra) (15.3) (0.1) (15.4) (Djambi) (1.6) (0.1) (1.7)

3. PERKINA, Unit III Java 0.1 - 0.1

4. PERMINA, Unit IV Kalimantan o.4 8.0 2.7 11.1 (Kalimantan) (O, 4 ) (8.0) (0.6) (9.0) (Bunju) (2.1) (2.1)

5. Institute of Petroleum Java 0.6 - 0.6

6. CALTEX Central Sumatra 15.5 10.3 10.5 74.9 111.2

7. STANVAC Central Sumatra 2.3 10.3 12.6 South Sumatra 8.0 0.3 8.3

0.4 32.4 0.5 18.3 0.6 20.8 97.1 170.5

1/ Residual between total crude output and deliveries to refineries; thus changes of stocks are included. - 2L -

75. The way in which the taxes charged to the oil companies are calculated is described in Appendix 2 of the main report. The following table gives the breakdown of the estimated foreign exchange transactions of the oil sector for 1967 and 1968 furnished by the Government to the Amsterdam meeting of the Inter-governmental Group.

Table 4

(In Millions of Dollars)

1967 1968 I. Foreign Oil Companies 1. Exports 173 233 2. Crude in kind for domestic marketing 9 - 3. Operating expenditures in foreign currency (including depreciation): (a) related to exports 26 26 (b) related to deliveries for domestic marketing 23 23 4. Investment income (40 percent of 1+2-3a) 62 83 5. Government gross share (60 percent of 1+2-3a) 94 124 6. Government net share (5-(2+3b)) 62 101

II. State Oil Companies 1. Exports 71 70 2. Foreign currency expenditures: (a) related to exports 34 33 (b) related to deliveries for domestic marketing 28 29 (c) related to imports of lubricants 11 13 3. Reimbursements to foreign oil companies: (a) related to cost and fee for domestic 23 23 marketing (see 1.3b) (b) related to crude in kind for domestic 9 - marketing (see 1.2) 4. Surplus/deficit -34 -28

III. Total Net Income of the Government (before debts repayments) I.5+II.4) 60 96

Note: Debts repayments (to Shell) 27 27

Source: Directorate General of Oil and Gas. - 25 -

76. Prospects For Crude Oil Production. The prospects for further growth crude oil production are indicated in the following forecast of the Department of Mines:

Table 5 Million Metric Tons

1967 25.7 1968 30.3 1969 38.4 1970 45.7 1971 6.9 1972 46.4 1973 48.3 1974 50.4 1975 50.5

77. The figures are based on the assumption that the explorations in the present areas will be 25 percent successful and that some new areas will come into production after 1971. The growth is to be expected in the Caltex area only. Accordingly, Caltex is expanding its port facilities at Dumai to ac- commodate 100,000 to 120,000 ton tankers by 1969 as compared with the present limit of 60,000 tons. Output in the North Sumatra area of Permina is assumed to remain constant. For all the other areas a decline by about 10 percent a year is to be expected. 78. This forecast, showing a significant increase during the period 1968 to 1970 and a leveling-off thereafter, refers only to the presently operating areas. Successful exploitation and accelerated opening up of the new areas could add an unknown quantity, beginning not prior to the early 'seventies. If none of the expectations should materialize,the growth rate of domestic fuel consumption would surpass that of production by 1970-1971, leading to declining exports thereafter. The implications of this forecast for the future foreign exchange earnings of Indonesia are discussed in Appendix 1 of the main report.

79 The input and output structure of the refinery industry is shown in Tables 3 and 7. Of the six units listed in Table 3, only three are "1refineries" in the strict sense. Even these are reported to be old and inefficient, though highly flexible with respect to composition of output. The Pladju (Permina, former Shell) and the Sungei Gerong (Stanvac) refineries are both located on the Musi River close to Palembang in South Sumatra. Owing to the decline of crude production in the adjacent areas, the Palembang refineries are now heavily dependent on supplies from other areas. A further complication is the limited draught of the Musi River bar (about 12' during the dry season, at low tide) which limits the size of tanikers to 8 - 10,000 tons, and which can hardly be dredged to accommodate more than 15,000 ton ships. Complicated navigational problems add to the difficulties. Output, Input and Deliveries of Refinery Products

(in 1000 metric tons)

1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 a) Gasoline (i. Avgas), 2600 2466 2572 2441 2403 2331 2400 2288 2134 1335 1789 n.a. n.a. 1203 b) Kerosine, 1256 1443 1638 1655 1668 1576 1640 1683 1732 1770 1632 n.a. n.a. 1460 c) Heavy oils, (incl. diesel 5700 5841 6001 6072 6727 6146 6835 6938 7115 8073 6156 n.a. n.a. 3590 fuels) d) Wax and paraffin, 112 119 122 106 93 90 102 104 91 92 70 n.a. n.a. n.a. e) Asphalt and cutback, 30 34 34 35 41 30 29 31 45 37 41 n.a. n.a. n.a. f) Others, 492 509 513 535 603 636 801 670 771 193 36 n.a. n.a. n.a. g) Losses 152 161 166 182 180 138 157 174 184 233 722 n.a. n.a. n.a.

Total refinery throughput 10342 10573 11046 11026 11715 10947 11964 11888 12072 11733 10446 9123 10018 9850

Domestic crude input 7937 8409 8420 8109 80148 8328 9852 9748 9459 10124 9031 9123 10018 9850

Imported crude input 24014 2165 2626 2917 3668 2619 2112 2140 2613 1545 1415 0 0 0

Exports of refinery products 7689 7618 6515 7814 7328 7446 7969 6514 5759 6549 5770 3615 4424 n.a. Domestic Consumption of refinery products 1/ 2501 2794 4365 3030 4207 3363 3838 5200 6029 4951 3945 n.a. n.a. n.a.

1/ Residual of thruput minus losses and exports; thus changes of stocks are included.

Sources: Central Bureau of Statistics Directorate General of Oil and Gas Bulletin of Indonesia, Economic Studies, Canberra, No. 6, pp. 68, 69. - 27 -

80. Comparison of Table 7 with the consumption figures in Table 8 re- veals the evolving bottlenecks of the Indonesian refinery industry: Demand for kerosene exceeds production, the gasoline and diesel oil surplus is very small and for gas oil the 1965 consumption was close to the 1966 production. The only remaining export refinery product of considerable volume is fuel oil. 81. Once the economy has recovered from the present recession, and overall demand resumes a rate of growth of about 6 percent a year as estimated by the Directorate (this estimate looks very conservative) shortages are bound to develop. Therefore, Permina is planning to build a new refinery near Dumai (the Caltex pipeline terminal port) with a capacity of about 55 million barrels per year, designed to top off the light distillates. The waxy residue is to be exported.

82. Price Structure for Petroleum Products. The present price (retail) structure for refinery products is about as follows:

Rupiah per Liter Equivalent U.S.4/gal. Gasoline 4 10.2 Automotive Diesel oil 3.5 8.8 Heavy diesel oil 1.25 3.3 Kerosene 1.75 4.4 Fuel oil (Tanker C) 1 2.5

(Exchange rate: Rp. 150 = U.S. $1,00)

83. These prices (which were established after an eightfold increase early in 1967) barely exceed those one would expect as cost ex refinery by international standards (in case of kerosene, they appear to be even belov that level). Thus, refinery products are subsidized. The mission was not in the position to analyze the involved transactions quantitatively in sufficient.detail. However, the major sqbsidy probably derives from the artificial exchange rate of Rp. 85/U.S.e,1.?/ Since this rate also applies to rupiah purchases by the foreign companies, it increases their costs of production.

84. In 1965 coal produced only about 4 percent of the total energy used in Indonesia as compared with 87 percent for oil. Coal had declined from 28 percent in 1950. Some of the problems of the coal industry are discussed further below. However, it seems to the mission that part of the difficulty that this industry is having to provide employment for some 7,000 workers can be laid at the door of the excessively low prices of petroleum products which do not reflect the opportunity cost of oil as an export. l/ However, this rate is an improvement over the situation prevailing earlier this year when the "transaction rate" of 10:1was used. Table 7

Structure of Operation and Output of the Refinery Industry, 1966

(in mill. bbls)

Aviation Gas oil Diesel oil Total Gasoline Gasoline Kerosene A.D.0. I.D.0. Fuel Oil Avtur Asphalt Waxes Other 1/ Losses thruput

1. Brandan PERMINA I - 0.027 0.038 - 0.007 0.003 - - - 0.071 0.008 0.154

2. Pladju (Palembang) PERMINA II 0.066 3.197 5.945 4.015 0.817 5.604 - - - 12.063 0.073 32.180

3. WonoKramo PERMINA III - 0.014 -. - 0.252 0.140 - 0.166 - 0.006 0.011 0.589

4. Balikpapan PERMINA IV - 1.822 1.940 2.258 0.394 2.586 0.977 - 0.237 8.173 0.o2 18.429

5. Tjepu Institute of Petroleum - 0.038 0.202 0.047 0.119 0.094 - - 0.006 0.011 0.013 0.530

6. Sungai Gerong (Palembang) STANVAc 0.048 5.300 3.183 2.425 0.706 5.592 0.552 - 0.234 2.170 0.231 20.441 00

Total finished product 0.114 10.398 11.308 8.745 2.294 14.019 1.529 0.166 0.477 22.494 0.778 72.323

Local artsumptin 0.200 9.400 11.700 6.100 1.900 4.250 0.450 n.a. n.a. n.a. n.a. n.a.

Export 2/ 0.086 0.998 -0.392 2.645 0.394 9.769 1.079 n.a. n.a. n.a. n.a. n.a.

1/ Residual between total thruput minus losses and output of other derivates.

2/ Residual betueen production and local demand; thus changes of stocks are included.

Source- Directorate General of Oil and Gas. - 29 -

Table 8

DOMESTIC FUEL CONSUMPTION (in 1000,bbls.)

I61 1962 1963 1964 1966

AI. Gasoline 143 189 191 202 193 200

Jet Fuels 147 358 373 404 432 450 Motor Gasoline 7,266 7,793 8,271 9,107 9,867 9,400

Kerosene 7,290 9,489 l0,005 10,289 ll,264 11,1700 Gas Oil (A.DO.) 46,005. 4,798 6,143 7,656 8,419 6,100

Diesel Oil (I.D.O.) 884 901 855 1,101 1,169 1,900

Fuel Oil 2,0142 2,108 2,418 4,46 4,605 -4,250 21,777 25,636 28,256 33,223 35,949 34,000

Source: Directorate General of Oil and Gas. - 30 -

85. Supply and Demand of Natural Gas. The following figures show the avail- ability of natural gas (both dry gas and associated gas) in 1966:

Table 9

(Billion Cubic Feet)

North Sumatra (Permina I) 5.344 Central Sumatra (Caltex, Stanvac) 9.070 South Sumatra (Stanvac, Permina II) 41.705 Java 5.611 Kalimantan (Permina IV) 11.191

Total: 72.924

Source: Directorate General of Oil and Gas.

86. Of this quantity, 15.7 billion is utilized at the fields for energy and reinjection. Another 5 billion is delivered by Stanvac from its South Sumatra area to the Pusri fertilizer plant near Palembang (about 50 percent of this is used for fuel). This isthe only petrochemical plant now operating in Indonesia. The rest of the gas is flared.About 8 billion cubic feet can be used in South Sumatra for new purposes including the proposed extension of the Pusri plant. However, the realization of this project would require reconsideration of the present pattern of utilization of natural gas in South Sumatra and the chemical composition of the gas may be a further problem.

87. Some commercially usable reserves of gas are expected in another area in North Sumatra, about 150 miles Northwest of Medan, which is now under intensive exploration by Permina I (operating the adjacent oil producing area.). If these expectations should materialize, the gas will probably be used for manufacture of carbon black and for LPG (both are under consideration). Another area of likely commercially usable reserves may develop in West Java (about 100 to 150 miles East of Djakarta), where scattered reserves of about 140 billion cubic feet are reported to be proven. - 31 -

THE TEXTILE INDUSTRY

88. From the standpoint of numbers employed and probably contribu- tion to GNP (value added), textiles is the most important of Indonesia's manufacturing industries. In 1964 it employed nearly 0 percent of all manufacturing workers (Appendix Table 1 ) or 290,000.1' This probably does not include many home workers who are engaged part time in weaving and other activities (including finishing "batiks"). Textiles are one of the nine "basic" commodity groups and the Government has placed more adequate supplies of textiles among its priority objectives after food.

89. The availability of the domestic supply of textiles seems to have varied between 400 and 800 million meters (or roughly between 4 and 8 meters per capita p.a.). Imports of made-up articles are not included in this calculation but within the total magnitude can be neglected. From the low level of consumption of 1966 the Government aims at a target of 5 meters per head in 1967 and at increasing 1 meter per head each succeeding year to reach 8 meters in 1969, and 10 meters by 1974.

90. Given the country's tropical climate, consumption is mainly cotton. Rayon plays a minor part, along with other synthetics to the extent that they are imported in finished cloth and ready-made articles. There are practically no woolen textiles required. Since Indonesia has no domestic textile raw materials (although some areas are said to be suitable for growing cotton), an order of magnitude for domestic con- sumption can be obtained by adding up the physical quantity of imported raw cotton, yarn, and fabrics and converting to fabric equivalents as in Table 1.

1/ Industrial Census of 1964. - 32 -

Table 1

Import of Textile Products and Materials

(In 1,000 metric tons)

Cotton/ (Total Bleached Fabric Year Raw Rayon Yarn cambric/ Finished Total Equivalent Cotton Yarn Availa- shirting Fabrics Fabrics (in milliT bility)i/ meters- 1954 5.5 10.9 15.7 24.6 24.0 48.6 496 1955 7.1 32.3 38.6 27.2 22.0 49.2 660 1956 7.8 32.0 38.9 25.2 21.8 47.0 644 1957 9.3 29.1 37.3 28.9 23.7 52.6 678 1958 8.1 30.1 37.2 18.6 16.6 35.2 538 1959 6.5 30.2 35.9 12.2 19.1 31.3 498 1960 11.1 58.7 68.5 14.9 11.9 26.8 622 1961 12.2 56.4 67.1 23.9 15.3 39.2 941 1962 10.6 29.7 39.0 20.0 11.6 31.6 701 1963 7.1 23.2 29.4 5.7 15.3 21.0 187 1964 4.4 27.4 31.3 6.5 11.4 17.9 447 1965 n.a. 45.5 45,53/ 11.1 7.4 18.5 6673/ 1966 n. 21.3 21.32' 5.9 13.3 19.2 692k" 1967 20.5!/ 14.4 32.4 n.a. n.a. n.a. 731

1/ Assuming 12 percent waste in spinning. 2/ Assuming an average yarn consumption of 0.145 kg. per meter in domestic processing and an average weight of imported fabrics of 0.125 kg. per meter. 3/ Not including imported raw cotton which was small in these years. IT/ Raw cotton equivalent of estimated domestic yarn production.

Production. The composition and development of the equipment in the industry is shown in Table 2.

Table 2

July November October 1935 1939-40 1955 1962 1964 1967

Spinning: Spindles 0 15,000 n.a. n.a. 178,000 420,000

Weaving: Power looms 414 8,000 12,700 20,300 n.a. 28,000 Hand looms 3915 44,000 78,900 224,000 n.a. 280,000

Knitting: Power n.a. noa. n.a. 2,088 n.a. 9,800 machines Hand n.a. n.a. n.a. 5,700 n.a. 1,200 machines Finishing: Capacity (negl.) (negl.) (negl.) 207 n.a. 220 i(mn . mtrs.) Source: The Textile Industry, Bulletin of Indonesian Economic Studies, No.2, - 33 -

91. The industry started towards the end of the colonial period with hand-weaving to which subsequently power weaving was added. The post-war extension of the weaving and finishing sector mainly took place during the 'fifties, that of spinning and knitting followed. The bulk of the exist- ing equipment was mostly purchased after 1955.

92. Spinning. The spinning of yarn in mills is a relatively recent development. Before 1965, only eight mills with 234,000 spindles existed and they mostly date from the late 1950's. Eight additional mills have now been added. Out of the sixteen mills with a total capacity of 420,000 spindles, four mills with 116,000 spindles are private enterprises. The balance are under the Central or provincial governments. Seven mills with 167,000 spindles, including all four private ones, are integrated with weaving; some of them have excess spinning capacity. Two additional mills with 60,000 spindles are under construction, to be in operation by the middle of 1968; another two mills with 60,000 spindles are planned for 1968-69.

93. The Ministry of Textiles expects the following availability of yarn in 1967:

From domestic spinning mills 18,000 metric tons Contracted to Taiwan spinning mills 7,200 metric tons Yarn imports 7,200 metric tons 32,h00 metric tons

94. The theoretical capacity of installed spindles is 38,000 tons (on a three-shift basis). Thus actual performance is less than half the theoretical maximum. The eight mills built before L965 are described as inefficient and in a state of poor maintenance. There was also a serious shortage of raw materials in the first half of 1967, uhich later in the year was overcome by deliveries under the PL 480 program. Since the arrival of' this raw material, the spinning industry is reported to have operated close to capacity. A considerable portion of the raw cotton supply has, indeed been contracted to Taiwan spinning mills to produce yarn for Indonesia.

95. The figures indicate that provided a constant flow of raw material is secured and the installed equipment is well maintained, the spinning industry could have covered the yarn requirements in 1967. After adding another 60,000 spindles, now under construction, yarn supply could be in- creased to 43,000 metric tons. This quantity, however, is insufficient to cover the present level of normal requirements provided all imports of fabrics were dispensed with.

96. The present economic situation of the Indonesian spinning industry looks favorable as compared to other industries in the country. In October 1967, locally produced yarn was sold at about Rp. 140 per kg. ax-plant, whereas the landed price of imported yarn was about Rp. 167 per kg, at the B.E. rate of Rp. 150 to a dollar. One of the most modern spinning mills in Djakarta reported a profit rate of about 3 percent on sales. The problem of shortages of working capital, common to.other industries, does not appear to occur in the spinning mills probably because the cost of the raw cotton has to be paid to the Government only after the yarn is sold. - 34 -

97. Costs of domestic production, however, are distorted by a preferential foreign exchange rate of 90:1 for raw cotton, as compared to the present (December 1967) B.E. rate of 185:1. If raw cotton were priced in at the later rate, this would boost cost of local production from Rp. 140 to Rp. 214 per kg. Imported yarns after adjustment for the increase of the B.E. rate from 150 to 185 between October and December would cost Rp. 205 per kg. That is to say, the present subsidy (preferential exchange rate) is the basis for the competitiveness of the Indonesian spinning industry. Abolition of the subsidy might have to be compensated by an increase of duty on yarn.

98. One of the major reasons for the lack of competitiveness appears to be the low productivity of labor. One of the most modern spinning mills with 30,000 spindles installed reported a total employment of about 1,000 persons, of which 660 are operative and 330 administrative personnel. The operative staff is two to three timej that of the average Latin American mill of similar size and output mix,/ The size of the administrative staff is also completely out of proportion; it is four to five times that of the total of integrated spinning and finishing mills of the same spinning capacity elsewhere.

99. Weaving. 3,000 of the installed 28,000 power looms are reported to be in public sector enterprises and only a fraction are part of integrated mills, The average installation is 35 looms per establishment. The bulk of the existing power looms are scattered among a total of 2,800 small-scale weaving enterprises. The same is true for the hand-weaving section for which 35,000 establishments with a total of 280,000 hand looms are reported.

100. The total theoretical production capacity (two shifts for power and one shift for hand looms) would be 382 million meters in power and 590 million meters in hand weaving. This total of 972 million meters would more than provide the 8 meters per capita goal referred to above. However, this picture needs a basic correction with respect to the hand-weaving section. Most of the hand looms, installed during the Ififties,have never been operative. The sole purpose for this investment was to get import quotas for yarn which sub- sequently was resold at a good profit. In addition, most of the once opera- tive looms have been shut down. Thus, one should omit the hand weaving from consideration, with the possible exceptions of some high-fashion hand weav- ing, or some cottage industry operations in remote areas. Both these fields certainly would account only for a small fraction of the existing capacity. With this in mind, one can say that the present capacity hardly matches the present level of demand for fabrics (see Table 1).

101. However, the present rate of capacity utilization is very low. In the hand-weaving section it hardly exceeds 5-10 percent On that basis, and on the assumption of the estimated total output of fabrics of 226 million meters, of which 70 percent (in weight) is in woven fabrics, the rate of capacity utilization in 1967 would be about 30 percent in the power-weaving section. A considerable portion of the installed capacity is reported to be completely out of operation, shut down for economic reasons, or inoperative

1/ Economies of Scale in the Cotton Spinning and Weaving Industry, U.N. Economic and Social Council, E/CN.12/748, February 1966. - 35 - because of lack of spare parts and repair. Another portion is working on one shift only. In general, large and integrated mills seem to be better off than small and specialized ones.

102. The present economic situation of the weaving industry is reported to be very weak. Competition from imports is severe since they are esti- mated to account for 50 percent of total demand for 1967. Imports are sold at prices with which a good deal of the domestic industry cannot compete. There are charges of foreign dumping and probably this does occur as in other countries. However, in view of the low domestic yarn prices (due to the preferential exchange rate on raw cotton) and the present level of protection, viz.:

White textiles, gray or bleached: 30 percent) ) plus 50 per- Printed or colored cotton textiles: 45 percent) cent surcharge

Other fabrics, including knit wear 105 percent plus 100 per- cent surcharge serious doubts arise with respect to the efficiency of the local weaving industry. 103. The mission feels that the low degree of integration and low pro- ductivity (unproductive equipment, excess labor force, insufficient skill of management in operation and marketing) are the major reasons for the lack of competitiveness. The shortage of modern finishing capacity (especially printing) complementary to local weaving have certainly added to the industry's problems. 10. The Department of Textiles is anxious to have import duties on finished textiles increased, and to have the sales tax levied on imported goods. This would widen the margin of protection by 20 percentage points since the 10 percent sales tax has just been abolished on domestic fabrics except for knitted goods.

105. Knitting. 280 enterprises are reported to be operating, totally in the private sector. Some of the larger knitting mills have combined weaving and knitting but a very small portion of the installed equipment is in integrated mills. The average number of power knitting machines per establishment is about 35, a total of about 10,000 machines. 106. The theoretical production capacity (two-shift) of the installed knitting equipment of about 230 million meters per year, compared with an actual output in 1967 of about 65 milion meters (assuming, as estimated by the Government, that the allocation to knitting is almost 30 percent of all available yarn in 1967 and an average yarn consumption of 0.105 kg. per meter). The resulting capacity utilization is almost 60 percent on one shift. - 36 -

107. The economic situation of the knitting mills is reported to be better than that of the weaving mills. Import duties of 105 percent give a more effective protection to local producers than the 30-45 percent in the weaving sector.

108. Finishing. Finishing capacity, mostly introduced in the late 'fifties, is limited generally to bleaching, starching and colandering. Printing capacity is still very short. This lack of complementary finishing capacity may be an additional reason for the low utilization of the weaving sector.

109. Eighty percent of the existing finishing capacity of about 220 million meters is integrated in large weaving or spinning and weaving plants of the private sector. In many instances the finishing capacity is in excess of the capacity of the other stages; most of this excess capacity is used for contract processing. In past years of somewhat larger output of cloth, it was customary to subcontract abroad for the finishing. Both the utilization of existing capacity and the economic situation of the finishing section is reported to be satisfactory.

110. In addition to the afore-mentioned industrial finishing, batik printing/dying is significant. This traditional craft is basically a cottage industry of a very labor intensive type. A considerable portion of it is a part-time activity, creating some additional income for the family. For that reason, any estimate of capacity and output is extremely vague. A figure of 100 million meters a year has been mentioned. The lower-priced batik prices are used extensively for village wear and the mrore expensive ones are sold to the tourists. The industry seems to be quite well organized, and has at least one large integrated textile mill providing it with cloth on which the designs are printed (or painted by hand),

Recent Economic Conditions in the Textile Industry

111. Over a number of years the handloom industry had been heavily subsidized by a preferential exchange rate for yarn imported through the State Trading Companies - in the same manner as all state enterprises who obtained foreign exchange at the rate of Rp. 10 to a dollar up to October 1966. However, the low cost of yarn benefited the mechanized weaving mills even more since they were in a better position to circumvent the middleman who at different stages absorbed most of the difference between the demand price and the abnormally low c.i.f. price for yarn. Yarn imports became so profitable that government spinning mills (although enjoying the same privilage for imported cotton) found that trade in imported yarn was more profitable and less painful than spinning. Raw cotton consumption continuously declined after 1962, and imports of yarn increased in 1965 to twice the level of two years before. - 37 -

112. This extremely lucrative but wasteful (of foreign exchange and domestic productive capacity) situation was corrected in October 1966 by increasing the exchange rate for imports of raw cotton nine times to Rp. 90 to a dollar.

113. Three factors came into play in the last three months of 1966 to produce a drastic movement in the structure of prices and costs of various stages in the textile industry. First, the cost of raw cotton to the spinning mills was reported to have increased from Rp. 3 per kg. to about Rp. 40 per kg. after October 3, 1966. The cost of imported yarn increased about 4 to 5 times to about Rp. 60 per kg., making imported yarn more expensive than domestically produced yarn which still benefited from an artificially low exchange rate for raw cotton. Second, the domestic price of cotton fabrics dropped sharply as a consequence of increased availability of foreign exchange under a Japanese "stop gap" credit, and massive import- ing of printed fabrics from Hong Kong financed with short-term foreign credits under the "tenpa cover" regulation. The timing of these arrivals produced irregular movements in textile prices. After imports under the Japanese credit were completed, prices recovered early in 1967, and in July 1967 they were some 10-20 percent above September 1966 prices which, in view of the change in the general price index, was still low.

114. For industry as a whole, the general cost-price squeeze could have some salutary effects. However, this extensive price adjustment is not without frictional difficulties. In the weaving sector (where the cost in- crease for yarn meets with the competitive price decline for fabrics) the handloom operators who are scattered throughout rural as well as urban areas, are less favorably placed than the mills with regard to credit, procurement of yarn (through established wholesale channels) and sale of cloth. The larger mills are able to obtain contracts for the Armed Forces, the Logistic Bureau, and other State Ehterprises in a period of increased supply and depressed private demand. The Government's policy of disinflation, the stoppage of construction activity and the discontinuation of subsidy prices for most goods and services has no doubt resulted in a sharp general reduc- tion of private consumer spending on items other than food during the last 10 months, and this is felt particularly by the textile industry. All these factors have contributed to a -recession situation for the textile industry, from which it is only slowly recovering.

115. Wide differences can be noted between different mills as regards their quality of management, technical efficiency, and operational costs, so that competition, wherever it is effective, should show results. The spin- ning mills, in spite of their being mostly government enterprises, have quite a novel opportunity to demonstrate financial and technical viability after so many years of featherbedding.

116. The principal longer-term problem is to balance the existing weaving capacity with a substantially enlarged spinning and finishing capacity. The predominance of handlooms in weaving is a question that cannot be commented upon without a detailed comparative study in cost and quality. It is clear, - 38 - however, that a large textile industry covering the major part of the country's clothing requirements should be an economic proposition for Indonesia in spite of the lack of domestic raw cotton. Excess labor is available at low cost, probably competitive with Hong Kong, and workmanship is good. M,7anagement and technical talent is mixed, as already noted, but is certainly capable of improvement. Projects exist for the domestic pro- duction of rayon as well as nylon and polypropylene.

117. At present Indonesia's import bill is still heavily loaded with textiles. In 1967, out of total merchandise imports of about $650 million, as much as a third may be for textiles. Imports of fabrics may be in the order of $1O million, yarn $16 million and raw cotton $20 million, according to government estimates. 1ith the improvement of capacity utilization currently hoped for, the import of fabrics could be reduced at least by half.

Growth Goals for the Textile Industry

118. In comparison to the present level of supply of about 6.6 meters per capita originating about 70percent from imports, the goal of 10 meters per capita appears high, particularly when combined with a self-sufficiency goal.

119. This would imply a total domestic production of about 1.15 billion meters of fabric and the required yarn would amount to about 165,000 tons. The existing spinning capacities plus the additional 60,000 spindles under construction would - assuming full utilization - produce about 42,000 tons of yarn per year. Another 1.37 million spindles would be required for self-sufficiency in spinning, or over a 300 percent expansion. On the basis of the most recent investment requirement estimates for Indonesia (two newly planned spinning mills of 30,000 spindles each: cost of invest- ment h.6 million plus Rp. 200 million each), installation of 1.37 million spindles would require about $210 million plus rp. 9.2 billion (without working capital).

120. The Department of Textiles is considering a more modest plan, namely to install 400,000 spindles over the five-year period or roughly double the present installation. This program would require about ',6l million and Rp. 2.6 billion.

121. As to the weaving sector, the Department of Textiles expects the elimination of most of the existing hand-weaving capacity except for some specialities or in remote areas where labor costs are very low. The existing power-loom equipment, if it could be brought up to full capacity, would meet less than 50 percent of the supply on the basis of 10 metelsper capita or, say, 25,000 more power looms would be required. The Department does not expect this, but is considering an addition of 6,000 units or an increase of about 21 percent. In this event the domestic industry could supply about $ meters per capita under the given assumptions of two shifts and 85 percent of the units in operation. - 39 -

122. No specific policy or consideration is reported with respect to the knitting sector. The high rate of un-utilized capacity of modern power knitting machines is the reason for lack of explansion plans.

123. The Department of Textiles is concerned about the limited finish- ing capacity, especially in the more sophisticated fields of dying and printing. This has to keep pace with spinning and weaving due to its complementary nature. Due to the high capital intensity, high economies of scale, and the required specific skills,. finishing has developed in many of the technically advanced countries primarily as a specialized industry in an intermediary role between the weaving industry and the market. A similar approach could be worth considering in Indonesia as the primary market outlet especially for the small and medium-sized weaving mills. For very big integrated textile mills, the attachment of a complete finishing department may be economical. The alternative approach, i.e. finishing in separate large finishing mills under contract of weaving mills, is to be considered as less favorable since operation of the finishing plants may be hampered by small lot sizes and the small and medium-sized weaving mills would still be faced with the marketing problem.

Assessment of the Present Development ProFram for the Textile Industry

124. The mission favors a well-balanced extension of the textile industry, but has some doubts with respect to the soundness of the ildicated program which seems to emphasize separate spinning and veaving establishments. It recommends further consideration. Major reasons for these doubts are:

(1) The competitiveness of non-integrated spinning mills is somewhat dubious without considerable improvement of the present level of efficiency;

(2) The achieved net foreign exchange savings per kg. of yarn is rather limited for separate spinning establishments. This saving may be estimated as follows:

Foreign Exchange Savings per Kg. Yarn (Basic Exchange Rate 150:1) Rupiah Import price (without duty) 187 Foreign exchange components in spinning: Cotton (116 per bale, 88 percent recovery) 92 Capital (repayment over 10 years) 28 Fuel and maintenance (50 percent assumed foreign exp.) 25 Interest (6 percent) 9

Net foreign exchange saving 33

The comparatively small saving is because of the missing domestic raw material basis and the comparatively small value added. - 40 -

(3) The integration of spinning and weaving renders possible considerable economies. For that reason emphasis should be given to developing integrated units, whether by sup- plementing existing spinning mills by complementary weav- ing sections or changing the program in the spinning industry to fewer but integrated units.

125. In view of the desirability of forming more integrated units (in addition to the present seven) the division of activities between the public sector (spinning) and the private sector (all other activities) presents a problem. The mission would favor integrated units in both sectors but, of course, with maximum reliance on the private sector where all units are already integrated.

126. The shortage of sophisticated capital intensive finishing may evolve as the critical bottleneck for the rehabilitation and extension of the. textile industry. This is a further argument for integrated units with their own finishing capacities or for specialized finishing units. PART III -PROJECTS

127. The mission examined three groups of projects in the industrial field. These were:

1. The undertakings for which aid should be requested as part of the 1968 foreign aid program.

2. Further action on suspended or retarded projects.

3. The industrial component of the Five-Year Plan which is to start in 1969.

128. The mission found that all three of these segments tend to merge. The input of development monies from the 1968 credits will finish certain plants under construction and automatically point the way to new action in the forthcoming Five-Year Plan. This Plan will be similarly affected by the outcome of the studies of, and decisions made in connection with the many retarded projects.

129. The number of problems inherited by the present government and the needed resolution of current economic difficulties may make it im- possible,for practical considerations, to evolve an intelligent Five-Year Plan by the scheduled date of June 1968. It may prove more prudent to schedule the completion of this work for 1969.

130. This apparent merging of the three segments, the need to complete current projects, the importance of determining future action on retarded projects, the necessity of clarifying some general factors, point to the wisdom of establishing a comprehensive "interim industrial program" as the sound beginning for a Five-Year Plan.

131. 1968 Program. Prior to the mission's arrival in Djakarta, the Government had decided to ask the Inter-governmental Group at the meeting held in Amsterdam on November 20-22, 1967, to provide, as part of the 1968 aid program, $75 million for "project" aid as differentiated from $250 million for general commercial imports to be utilized through the B.E. mechanism. The mission's task was to see if such aid could be economically utilized. This program is confined to public sector enterprises since the needs of the private sector will be met from other sources including the $250 million.

1.32. After an investigation of each industrial undertaking proposed by the government agencies concerned, the mission concluded that projects and other undertakings with a total cost of $81,653,000 could be included and that about $17,103,000 might be disbursed in a year following the mean date on which commitments are made. The undertakings selected by the mission are listed in Table 1 . Some details on each of these items and the mission's observations about work that needs to be done on the enter- prises involved is in Appendix 1 to this Annex. In some instances, the - 42 - mission went into more detail than may seem justified by the investment involved, but this was to illustrate problems of general occurrence in Indonesia and to make suggestions on the improvement of projects, either new or under construction. However, apart from a few cases specified, we did not think it necessary to recommend preconditions for the commit- ment of this aid.

Table 1

Recommended Industry and Mining Projects - 1968 Program

Foreign Estimated Exchange First Cost of Year Project Disbursements

1. Gowa (South Sulawesi) Paper Project 320 320 (Equipment for water installation) 2. Pematang-Siantar (North Sumatra) Paper 300 300 Project (Power supply) 3. Tonassa (South Sulawesi) Cement Project 75 75 (Transportation equipment) 4. Caustic Soda Chlorine Project, Waru (East 750 750 Java) (To produce liquid chlorine for paper plants) 5. Palembang (South Sumatra) Tire Project 113 113 (Additional diesel generating sets to increase production capacity) 6. Rehabilitation and Replacement of Salt 500 500 Barges for Madura (East Java) 7. Tin, Bangka Island 21,745 12,295 (a) Rehabilitation of Smelter 99 (b) Rehabilitation of Dredgers 12,150 2,700 (c) New Dredgers 8,000 8,000 (d) Electric Mines (Equipment) 1,000 1,000 (e) qew Slipway 500 500 8. Pusri Fertilizer Plant, Palembang, South 50,000 1,000 Sumatra (Expansion by 300 percent of present capacity) 9. Gresik Cement Plant, East Java (One 2,000 500 additional kiln) 10. Spinning Hill 4,000 1,000 11. Electric Power (For spinning mill and 1,600 - other uses) 12. Bandjaran Spinning Mill, West Java 250 250 (Temperature and humidity control equipment) Total: 8165_7,0 Total: 81,653 17,103 - 43 -

133. The background for the selection of these undertakings will be of interest to possible donor countries. When the present Government came into power in 1966, all industrial projects under contract for the supply of equipment from overseas or for the construction of factory buildings and facilities were carefully reviewed, particularly in view of the problems of external indebtedness and rupiah availability under the stabilization program. Following this screening, industrial projects were placed in one of two categories, (a) approved for completion, or (b) suspended. With a few exceptions all the projects on the 1968 List were classified as approved for completion.

134. The projects which were approved for completion had to meet an appropriate group of the following criteria:

1. The project was well advanced and most of the equipment had arrived.

2. The products to be produced were acceptable in the market and were in short supply.

3. The production processes appeared efficient.

.. The product from the project would support one of the specific development goals (other than control of inflation) established by the present Government, namely enhance the avail- ability of:

(a) Food production (b) Exports (c) Infra-structure (d) Textiles and shelter

* The amount of rupiah required was relatively small.

135. In turn the remaining projects were classified as suspended or retarded because the project was open to question on one or more of the following grounds:

(a) The site appeared inappropriate; (b) The amount of expenditure on infra-structure required was abnormally high; (c) The overall cost of the project appeared high in relation to output; (d) The unit cost of production was predicted to be excessive; (e) Doubts existed regarding the market acceptability of the products; (f) The financial plan was unacceptable to the present Government; (g) The rupiah requirements would be excessive. - 44 -

136. The mission suggested deleting some of the items from the list of approved projects and the modification of others. It.also suggested three additional projects. The three additions were projects on which, in the opinion of the mission, some start should be made in 1968 despite the fact that the commitment would extend into the succeeding two or three years. These were a new cement kiln at Gresik, a textile mill at Makassar and an addition to the urea plant at Pusri.

137. In all cases the suggestions of the mission were substantially accepted.

138. As will be apparent from Appendix 1, the inclusion of an item does not mean that we were satisfied with all its aspects. As in other sectors of the economy, the most common shortcoming is in management. In some cases, of course, substantial further investments will be required in subsequent years to bring the enterprises to efficient operation.

Retarded Projects

139. Similarly, an investigation was made of each project appearing on the suspended or retarded list.

14o. It has now become evident that the previous government committed basic errors of planning in connection with most of these projects. The present Government is wisely intent on making a serious re-evaluation of the projects from an economic viewpoint during this suspension period. Therefore, it is possible that some of these projects will be dropped or modified as a result of this re-evaluation.

141. Concurrently, the Government hopes that the continuing rupiah shortage as well as many of the inherent technical problems can be overcome by encouraging foreign investors to take over or carry forward some of the projects on such revised technical and economic bases as may prove necessary. It is hoped that the new foreign investment law will encourage such action. Potential overseas investors have exhibited some interest in several of these retarded projects.

142. However, the mission would expect that the Government must plan to perform the comprehensive studies required and determine the solutions. Serious investor interest in any one or more of the projects would be a boon but should not result in false hopes or cause further costly delays.

143. The members of the mission visited several of these projects and there is included in Appendix 2 a separate report on each of the following projects containing a definition of the apparent problems and a suggested course of action: L54 -

(1) The Trikora Steel Project at Tjilegon, West Java, in which comments are .also included on the retarded iron and steel projects at Kalimantan and Lampung.

(2) The Road Roller Project at P.N. Barata - Surabaja.

(3) The Diesel Assembly Project at P.N. Bisma and on the other retarded diesel assembly project at P.N. Indra.

(4) The Petrochemical Complex in Gresik, Super-phosphate Plant at Tjilatjap and the Sulfur Project at Carut and Liarnaradja.

(5) The Aluminum Project at Mabar, North Sumatra.

(6) An Electric Bulb Project - Semarang, Central Java.

(7) Welding Rod Plant - Djakarta.

(8) A Shipyard at Makassar, South Sulawesi.

(9) Electric Motors and Generators - P.N. Metrika, Djakarta.

(10) Paper Projects at Martapura, South Kalimantan, Atjeh, South Sumatra and Batang, Central Java.

(11) Plywood Project at Palopo, Central Sulawesi.

(12) Citronella Project, Tawangmangu, Central Java.

144. With respect to the remaining projects on the "retarded" list, dis- cussions were had with competent government officials and brief notes on these projects are also included in Appendix 2. It will be observed that the Ministries are already taking appropriate steps to clarify the conditions and possibilities for several of these projects.

Five-Year Plan

.145. In this section we will endeavor to indicate some of the more promising fields of industrial development within the guidelines established by the five goals previously mentioned, namely, increase or contribution to the increase of food production, support of infra-structure, increase exports and provide adequate clothing and shelter.

146. There are many important and obvious projects within the scope of these priorities which can make an important contribution to the industrial growth of the country. Many have already been undertaken and are listed in Appendix 1 and 2. Without doubt the number and size of these projects will exceed the staff and equipment necessary for early completion as well as the credit lines available. - 46 -

147. Before entertaining proposals along these lines, it would be advisable to state publicly and more definitively the basic qualifications which projects must meet to receive serious consideration. It is suggested that the projects might be required, inter alia, to meet the following criteria:

Only those projects would be considered,

(1) which expand existing industries or initiate new industries contributing to the following goals;

(2) whose product (on a basis of total cost) contains more than 70 percent of indigenous materials and labor;

(3) whose size is equal to, or greater than, the minimum eco- nomic level considered acceptable by international standards or can reach that level after an expansion not greater than 100 percent;

(4) whose selling price requires little or no protection after a limited period in which it reaches capacity operations at the afore-mentioned minimum economic level unless clearly established external economies are present.

1h8. As indicated in the discussion on the interim development program for 1968 a great deal of the work performed therein to correct existing difficulties will afford the basis for selection of probable areas of further development. In other cases, additional specialized studies may be required.

149. A five-year plan might evolve, containing the following projects and requiring approximately the foreign currency credits indicated. Although very preliminary and conjectural, this list may be helpful in indicating one direction for planning and an order of magnitude of the foreign exchange costs. It is, of course, to be hoped that many of these projects will prove of interest to foreign interests. The list is offered as a check list for study rather than a firm recommendation.

I. Assistance to Agriculture

150. In this broad field, the immediate and direct contributi.on from industry will be the additional quantities of fertilizer from the following projects already considered:

(a) Expansion of urea or other nitrogenous fertilizer production at Pusri, cost $50 million;

(b) Conversion of Gresik to ammonium phosphate and installation of a mixed fertilizer unit, $8 million; - 47 -

(c) Conversion of Tjilatjap to triple phosphate and the addition of a mixed fertilizer unit, $8 million;

(d) Extraction of sulphur contained in the volcanic mud at Warnarajda, $3 million.

II. Support of Infra-Structure

(a) Expansion of Gresik Cement Plant by the addition of fourth kiln, $4 million; (b) A new 400,000 tons cement plant near Djakarta, $12 million; (c) Carbon black production for rubber tires, $2.5 million.

III. Increase of Textile Production

(a) 30,000 spindle plant at Padang, $4.6 million (in addition to the one at Makassar included in the 1968 program); (b) A new large integrated textile mill, $10 million; (c) A possible project for the indigenous production of spinning and weaving equipment, $4 million (this will require parti- cularly careful study).

IV. Expansion of Exports

(a) New plywood plant, $8 million; (b) Further increase in tin production, $10 million.

V. Import Substitution

(a) Pulp and paper plant at Takegon, $26 million; (b) Kraft paper plant at Notog, $18.5 million; (c) Increased production at Gowa, Banjuwangi and/or Letjes, $10 million.

VI. Improvement of Contribution from State Heavy Industries Corporations

(a) New machinery for the production of metal articles, $4 million.

VII. Expansion of Chemicals and Plastics

(a) Caustic soda and soda ash at Madura, $9 million; (b) Polyethylene low density, 25,000 tons per year, $15 million; (c) Polyvinyl chloride, 25,000 tons per year, $15 million.

151. The foreign currency credits required for this program would total roughly $222 million. It is reasonable to assume for planning purposes that an equivalent value in rupiah would be required to cover local construction and installation expenses plus working capital.

152. The fertilizer projects aid labor-intensive agriculture and accom- plish through import substitution both job creation and foreign exchange savings. Expansion of cement production creates additional jobs in the - 48 - mining of raw materials, construction of buildings and homes and extensive road construction. The textile plants are labor intensive and will create jobs for Indonesians now performed overseas. The plywood and paper plants create job opportunities in logging. The caustic-chlorine plant requires a high labor input on Madura to produce additional salt. Polyethylene and polyvinyl plants consume indigenous raw materials and spawn secondary industries which are highly labor intensive.

153. As noted above, listing of these particular projects and the assign- ment of a probable investment figure is presented solely for preliminary plan- ning purposes. Obviously the studies to be carried out will eliminate or modify some and add others. The cost estimates will become firmer as the studies progress.

154. A few comments are pertinent to the project under III(c) above, which is the domestic production of spinning equipment. If the Government pursues the present policy of installing enough spinning equipment to match the installed weaving and knitting capacity, which seems sensible, then a substantial number of spindles will be purchased. This suggests negotiation to induce a foreign investment or the purchase of drawings and know-how for the production of this equipment under royalty.

15. Frames might be cast at Barata or Boma. Machine parts could be manu- factured by several different companies, including the Army Workshop at Bandung, the assembly could be performed by a third company. A relatively little addi- tional capital expenditure would be necessary. It would appear worthy of investigation, particularly because it is labor intensive and adds new skills in addition to the benefits of import substitution.

156. The tendency in many developing countries is to wait until the credit is available before undertaking to prepare a comprehensive project study. The result is that studies are hurried, investigations are inadequate and the project is generally tailored to the credit instead of to the country's needs. This practice was apparently formerly followed in Indonesia. It cannot be emphasized too strongly that the lack of well-prepared projects is the greatest deterrent to obtaining loan or investment capital for proposed undertakings. Therefore, it is urged that when preliminary studies indicate the wisdom of a particular development the necessary staff and funds be assigned to thoroughly prepare a project report. The information that should be contained (inter alia) in such a report is as follows:

1. Description of the products and the quantities which are to be produced at the designed capacity of the plant.

2. Information on the extent of the market and a justification that the production of the plant can be sold in the quantity produced and at the prices indicated over the first five years of the plant life.

3. Substantiation that the proposed plant is of an economic size based on international standards and that it will produce competitively priced products. - )49 -

4. The name and location of existing plants elsewhere, using the the proposed processes and of the same size which are success- fully operating at the present time.

5. The provisions, if any, that have been made for subsequent expansion and what the probable incremental capital cost will be per installed annual unit of production compared with the capital cost for the basic plant.

6. The country from which it is intended to purchase the plant, the extent of the credit line obtained, if any, with the applicable interest rate and repayment schedule. Other than the down payment, the first installment should not become due earlier than 12 months after the plant has completed a substantial test period at or above design capacity.

7. The arrangements that have been made for the supply of the necessary technical competence and continuing know-how together with the amount of annual charges for such services.

8. The performance guarantees to be given by the equipment supplier and the applicable penalties.

9. The financial plan showing principal shareholders including foreign investors. The financial plan should make adequate provision for working capital and should indicate the source of additional funds for any unforeseen overrun in capital costs that may occur.

10. The location of the proposed site and whether it is owned or under option. Include evidence of adequate load bearing characteristics of the soil, the availability of adequate water of suitable quality and provision for disposal of effluent.

11. An earnings statement, cash flow and balance sheet setting forth the construction period by quarters and then covering the first five years of operation with the initial year by months, the second year by quarters and the remaining three years by six months periods.

12. The percentage of output to be exported, if any, and a list of firm sales contracts if they exist.

13. The net foreign exchange savings by import substitution plus net exchange earnings, if any, after deducting debt repayment and interest service charges.

14. The amount of foreign exchange, if any, required to cover the import of raw materials when the plant is operating at designed capacity. - 50 -

15. The amount of foreign exchange which the company intends to request for spare parts after the firsttwo years of operation.

16. The import tariff protection required, if any, and for how long.

17. The number of employees which the operation will require.

18. The breakeven point including debt service, (a) at designed capacity with varying selling prices; (b) at predicted selling prices with variable production.

19. The percentage of indigenous raw material and labor at full manufactured cost with operations at design capacity.

20. Whether all items of equipment available from Indonesian manu- facturers will be used to reduce foreign exchange requirements and list the items which are available locally but unsatisfactory in quality, price or delivery.

21. Recognizing the excessive costs resulting from unwarranted long construction time tables, state the proposed construction sche- dule and provisions made to assure adherence thereto.

157. From the above list, it can readily be understood that the accom- plishment of these studies will require the assignment of a considerable number of persons. Experience dictates that these men cannot concurrently perform other ministerial or industrial duties. It would be well, therefore, if some consideration were given to the establishment at the proper govern- mental levels of an organizational group or groups of adequate size and competence that can give their undivided attention to the preparation of the elements needed to carry out the industrial aspects of any envisaged five- year plan.

Technical and Managerial Assistance Requirements

158. The following foreign technical aid will be required to carry out the industry program in 1968 and subsequent years. The mission has suggested many points for further study. The more important are summarized below. The size and complexity of the problems currently facing Indonesian industry become more easily manageable if they are discussed in relation to the major industrial groupings. The following is a suggested program of technical and management assistance in these various fields. - 51 -

1. Pape

(a) The Directorate General of Chemical Industries should obtain specialized assistance(and assign thereto a competent liaison representative)for the purpose of suggesting the improvements needed to bring the paper plants at Gowa, Letjes and Banjuwangi to their maximum design capacities, to improve the product quality to international standards, to enumerate the improve- ments in production methods necessary to achieve acceptable production costs, to determine the wisdom of future expansion in quantity or types of product,and to suggest a plan by which these ends can be attained.

(b). Specialized personnel would similarly be requested to determine the economics of the proposed paper plant in South Kalimantan and to determine whether its construction should be continued or the equipment moved to an existing paper producing location, or elsewhere.

(c) An additional request would be made of this personnel to deter- mine the economic size for a Kraft paper plant and whether the site at Notog is logical. An outline of the format to be followed and the specific points to be covered in a subsequent comprehensive project study should also be requested.

(d) Similarly, the size of the proposed pulp and paper plant at Takengon would be reviewed to determine the proper economic size, the product mix and the suitability of the site. An outline for a project study should be provided by the tech- nical assistance group.

2. Fertilizer

The Directorate General of Chemical Industries and the Minister of Agriculture should arrange for specialized assistance and assign thereto capable liaison representatives to resolve the following problems:

(a) In the development of the local production of fertilizers for the improvement of agricultural output,is it planned to supply to the farmers a mixed fertilizer of suitable composition or to produce and sell individual fertilizer elements or both? If mixed fertilizer, where is it to be produced and what are the compositions required? Would it be suitable and economical to locate such mixed fertilizer plants at the present fertilizer sites of Pusri, Gresik and Tjilatjap? (b) There exists, as outlined in the report on the Tjilatjap project, the corollary problems of whether the present project which is a single superphosphate mill will produce a product that will be acceptable to the farmers and whether the project can and should be converted to the production of triple superphosphate and even to a mixed fertilizer unit.

(c) As indicated in the report on the petrochemical complex at Gresik, the question arises as to whether it would not be better to convert the present proposed production of sulphuric acid to the manufacture of phosphoric acid and ultimately ammonium phosphate rather than the low concentration compound ammonium sulphate. At Gresik it would be useful to have installed the necessary equipment for the production of am- monium chloride, using available ammonia at Gresik with surplus chlorine from Soda Waru. Will ammonium chloride be accepted and can the equipment be readily installed?

(d) In connection with the expansion at Pusri, the question arises as to whether all of the expansion should be in the form of urea or some other product in connection with a mixed fertilizer program if suchis adopted.

(e) There will need to be an early resolution of the estimate of natural gas available in the Pusri area so that the extent of the fertilizer expansion there can be determined. In this connection, it will be essential to determine the comparative economics of converting the boilers to fuel oil for the purpose of saving the gas for feed stock.

3. Steel

159. As pointed out in the report on the retarded Tricora Steel Project at Tjilegon, it is essential that the Director General of Basic Industries obtain the specialized assistance necessary to determine the long-term needs of Indonesia for different types of steel and to evaluate the three existing iron and steel projects of Tjilegon, South Kalimantan and Lampung against those needs and in particular to determine what disposition should be made of the equipment now located at Tjilegon.

Program Implementation

160. As with most programs, implementation will doubtless prove to be more difficult than the enunciation of the problems. The key requirement to substantial accomplishment in this interim period is personnel with the corresponding specialized talents.

161. Indonesia may be on the way towards filling this void. It is understood that the Government has requested specialized personnel from the International Executive Service Corps in New York, which in turn is hopeful that arrangements can be quickly finalized and a program of service and assistance mounted. 162. Information available indicates that this Service Corps operates on the following pattern. Retired executives with outstanding records of industrial accomplishment and experience volunteer, or are requested to provide, their services without recompense to companies in developing countries. The travel costs and hotel expenses for the volunteer and his wife together with a small contribution to the Service Corps overhead are borne by the company assisted. Similar services are understood to be available from Canada and Japan.

163. This service may afford a fast, incisive and productive attack on a number of the problems simultaneously. While certain of the problems such as steel and fertilizer may require a team from a consulting firm, it is probable that one of these volunteers would be helpful in preparing the de- tailed terms of reference for the study thereby saving valuable time.

164. If these services are deemed useful and Indonesia completes arrange- ments for their use, it is suggested that volunteers be requested who have specialized knowledge and experience as:

(a) Production Manager of a paper plant to provide advice to Gowa and Letjes.

(b) President or General Manager of a paper company to advise on the South Kalimantan, Notog and Takengan projects.

(c) General Manager of a mixed fertilizer company to advise on this general problem with respect to Pusri, Gresik and Tjilatjap.

(d) President or General Manager of a large diversified metal working company to advise on the possibilities for improving and consolidating the several state corporations in this field.

(e) General Manager of an alkali-chlorine company to advise on the size, type and location of such plants to meet Indonesia's needs.

(f) General Manager or Production Manager of an edible oil produc- ing company to determine viability of the retarded "profit sharing" oil expeller and distillation plants.

Management Training

165. For reasons, which are quite clear, the depth of trained management talent in Indonesia is inadequate for the future development of the indus- trial potential. 166. In industrial countries training facilities have rapidly been extended for advanced training and "refresher" courses. Universities have established undergraduate and graduate business management curricula. 'any developing countries have recently made a start in this direction.

167. There is already an awareness of this need in certain circles in Indonesia. Recently P.T. STANJVAC carried on a training program for their staff under the guidance of a team recruited from overseas business schools. The participating staff was relieved from all responsibilities for a three week period. Such programs are widely needed.

168. It is therefore suggested that a series of specialized management training courses for each level of industrial management be arranged promptly and offered to the interested personnel of private and state corporations.

169. It is also suggested that the universities give consideration to the expansion of their curriculum in the business management field.

Phasing of Work and Planning

170. It would appear that the first step to an intelligent five-year plan is to utilize 1968 as a transition period as the Government has so designated. But the term "transition" fails to portray accurately the sense of urgency that is essential if the industrial climate is to be improved rapidly. It would seem that in 1968 the authorities might concentrate on clearing the decks of the project debris in the industrial field. It would be the most advantageous year in which to modify those regulations and those economic factors that are and will continue to impede the rate of economic development.Changes in the basic conditions will materially affect the planning process.

171. Assuming that this concept of a transition year is acceptable, it becomes immediately obvious that the experienced executive personnel in the Government is inadequate in number to perform the job within a reasonable time limit. It is also understandable that the specialized experience re- quired to resolve some of these industrial difficulties is not immediately available in Indonesia. At this point, it is only fair to state that the ability to study complex industrial situations and to prepare comprehensive project studies has been clearly demonstrated by certain of the Ministries.

172. If the existing problems are to be resolved quickly, it is neces- sary to emphasize that the number of qualified persons is inadequate and the specialized knowledge limited or unavailable. To this end the mission has stressed that a sizeable expenditure for technical assistance is a matter of paramount importance if Indonesia is to clear the decks in 1968 through the resolution of existing problems and lay the ground work for an intelligent industrial development. In developing a suggested approach to the overall problem, it will be assumed that funds for the technical assistance outlined above can be made available immediately. APPENDIX 1

1968 AID PROGRAM

1. PAPER PROJECT GOWA - MAKASSAR - SOUTH SULAWESI

This is a new plant just getting underway and since it has many problems we went into it in some detail. The mission visited the plant specifically to determine the justification for the request of a 5 km. water pipeline with ancillary equipment costing $245,000 plus Rp. 70 million.

The Plant

1. Capacity. 9,000 ton/year writing and printing paper to be made from bamboo.

a. Plant Description.

(i) Equipment supplied under war reparations by Kanematsu of Japan at a cost of $6.7 million.

(ii) Equipment includes:

(a) Three diesel power generators - each 1,875 kva (b) Water treatment plant (c) Chlorine and caustic soda plant (d) Pulp mill - 2 digesters - total output 30 tons/day (e) One paper mill tested at 1.4 tons/hr.output but inadequate in drying capacity (f) Sulfite process

2. Construction and Erection and Guarantees

(i) Construction work, started in 1961 and completed in 1966, was directly under Department of Basic, Light and Power Industries.

(ii) Japanese suppliers sent erection supervisors and a separate team to start up plant. The Japanese Start-up Team stayed for 9 months. All Japanese engineers have departed although the plant has not reached rated capacity.

(iii) During trial operations the plant reached output of only about half rated capacity. The supplier had also guaranteed con- sumption rates for power and chemicals which have not been achieved. - 56 -

The Indonesians were partly at fault because they Could not provide lime and salt up to specifications from domestic sources and strict control of imports unwisely precluded importation of even limited test quantities. Thus the whole issue of guaranteed performance and chemical consumption rates is confused. While pulp digestors met output require- ments, the screen for the paper machine and the filtering section failed to handle design capacity which created serious bottlenecks. Despite these handicaps and while using temporary provisions the paper machine tested out at 1.4 tons/hour which meets rated output.

The Japalese supplier is said to be redesigning the screen but little is being done on the filtering section. At least no advice on these items and issues has been received from Japan. Certainly the problems are neither sharply delineated nor well defined.

(iv) The chipper is not properly designed and requires frequent repair. Evidently, it is not a bamboo chipper but a wood chipper. It should be completely redesigned or adequate replacements supplied from the Japanese sources.

(v) In spite of the several important equipment deficiencies, the plant has been taken over because of the management's haste to begin commercial production. It is reported that the supplier desired to postpone takeover and commercial production until the necessary corrections were made.

3. Operations

Since take-over the plant has been producing at 40 percent of rated capacity on a three-shift basis. Aside from the bottlenecks in the plant, there are numerous other problems that affect adversely the quantity and quality of the product:

(a) Raw materials are not up to specifications. (b) The operators still need training; out of a total employment of 800 persons, 50 persons have had 6 months and one man has had 10 years of paper experience. However, none of this previous experience has been with bamboo as a feed stock. (c) The Company is having difficulty with the recovery system which has been closed down for extended periods. (d) Difficulties have been encountered in the bleaching process primarily from lack of experience. (e) The paper scrap rate is reported to be 15 percent but from appearance it seems higher. Waste paper is collected for months instead of being repulped daily. - 57 -

(f) Whereas staffing has been completed for three shifts, the training program is still on paper because there is no one capable of giving training. (g) No long fiber chemical pulp is blended with the bamboo pulp, resulting in an inferior paper quality which, therefore, commands a lower price than imported paper. (h) The Makassar area only consumes 150 tons/mo. of paper and consequently the balance of the 900 tons per month output at design capacity will have to be sold in other islands. As usual, inter-island freight exceeds the cost for longer ocean voyages. The lowest offer from Makassar to Surabaja is Rp. 5/kg, whereas freight from Japan to Djakarta is Rp. 3.0/kg ($20/ton). This differential can doubtless be overcome when proper operations lower Gowals production cost, making it possible for Gowa to absorb this differential if necessary. Until that time, Gowa correctly anticipates great difficulty in competing profitably in the Surabaja or Djakarta markets. The selling price of paper from Gowa is approximately equivalent to $200/ton. (i) With somewhat higher efficiency next year, the Company expects to break even at 20 tons per day. It hopes to reduce this break-even point to 15 tons per day. A great effort by the management and staff will be required to attain these goals. In the break-even analysis, depreciation of only Rp. 16 million is included, which is extremely low and obviously based on non-revalued historical costs.

Bamboo Supply. The Project has a 50,000 hectare forest from which to draw bamboo. To produce at design capacity will require the production from 2,000-3,000 hectares of bamboo forest. An input of 150 tons per day of air-dried bamboo is needed to produce thirty tons of paper. When roads are built deeper into the bamboo forest reserve, it is estimated that twenty km to 3-1/2-ton trucks will be needed to transport the bamboo over the 35 the plant.

The company estimates that the Forestry Department which owns and controls this forest will need to spend Rs. 50 million to develop the reserve. The present practice is to harvest the entire bamboo clump rather than to perform selective cutting permitting the clump to regenerate itself without replanting. Replanting when necessary will be performed at the time the old clump is harvested. If selective cutting were later adopted at Gowa, the bamboo flowering cycle will require attention to assure continuous bamboo supplies. With the selective cutting practice followed in other countries, attention must be given to the flowering cycle of the particular bamboo species since flowering portends the end of the clump growth. - 58 -

From discussions and observations, the raw material supply did not seem well organized. This may be the responsibility of Directorate General of Forestry rather than the Gowa management. Certainly the best organization and most eccnomical practices are essential in order that raw material costs may be minimized.

Water Supply. The management finds that the water supply is inadequate during the summer months when the river flow decreases substan- tially. To supply the factory in these periods the dam must be opened to raise the river level above the present intake. This practice is inefficient and results in over 60 percent of the released water being wasted. This waste is unfair to the farmers who share the reservoir and will be a continu- ing danger to capacity plant operations.

This condition has led to the present proposal to install a 5-km pipeline to the reservoir togetner with a pumping station to assure adequate water supply to the plant at all times. The mission supports the request and its early implementation.

Working Capital. According to the company's estimates an additional working capital of Rs. 23 million is needed. This appears to be a relatively low amount, but may be sufficient when added to the working capital at the company's disposal presently. The working capital calculations were not checked by the mission. However, during the mission's visit the management was very distraught at the failure of a messenger to arrive daily from Djarkarta with rupiah funds.

Management and Technical Assistance. The management at all levels appeared weak and this is attributable to inexperience. However, the upper levels of management seem adequately motivated and it was a sign of intelli- gent management and certainly commendable that the General Manager readily emphasized the need for technical assistance. It bears repeating that the equipment is poorly designed and improperly balanced; all of which imposes an undue burden on inadequately trained personnel.

There are three possible courses of action:

(i) To have the Japanese suppliers make the required corrections, even if necessary under a new contract, provided there is a guarantee of output upon completion of the work. Under this course of action it may also be advisable to obtain from a Japanese paper manufacturer continuing tech- nical assistance over a twelve to eighteen months period for operating the factory.

(ii) To retain an independent paper consulting firm to study the plant and make recommendations to bring the plant up to or above design capacity. Have the consultant perform the engineering of the modifications required, supervise the installation of the modified equipment and assist in staff training. Hopefully the Japanese suppliers could be persuaded to supply the modified items at no cost in fulfillment of their basic contract. - 5~9 -

(iii) In addition to or in conjunction with the consultants, invite in an experienced paper producer to give technical assistance for operations return for a favorable option on existing share capital or in a subsequent expansion. It must be recognized that only a strong inducement would per- suade a successful paper producer to give this assistance under existing circumstances. The corrections to the plant should be installed as soon as possible, and operating assistance obtained at the earliest moment.

2. PAPER FACTORY - PEMATANG SIANTAR, NORTH SUMATRA

This 15-ton per day newsprint paper plant is presently operating the Department of at 35% of design capacity. Since its transfer in 1963 from Veterans and Transmigration to the Department of Basic Industries, a careful investigation shows two reasons for under-production: inadequate water supply and inadequate electric power.

Initially the water supply has been obtained from a deep well. As a result of withdrawing the large volume of water needed for paper production, the water table has been lowered substantially. Further damage is being prevented by withdrawing the water requirements from a nearby river.

To assure adequate power an additional diesel generator of 1250 KVA with accessories and a short transmission line is required. With these corrections it is predicted that the production can be brought to design capacity.

The mission recommends that the $300,000 request be met.

3. TONASA CEMENT PLANT - TONASA, SOUTH SULAWESI

The plant was visited to investigate the request for aid in the amount of $118,000 for a bag plant plus Rp. 15 million for its installation expenses. This is to supplement a cement plant now under construction.

The Cement Plant

Capacity. 120,000 tons/year of Portland cement. - 60 -

Project Status. The project has been under construction for six years. Delays have been caused by the lack of rupiah financing. The contract was let in 1960 and the site preparation began in 1961. Most of the civil works have been completed. The silos will be completed shortly. Refractory lining installation is underway. The power station is nearing completion. The project is scheduled for completion by July 1968 and this date appears reasonable of attainment.

Process. The wet process was selected because the limestone has a L% moisture content. During the rainy season the moisture content of the limestone naturally increases and calculations showed the wet process to be more favorable and easier to control. Another reason the wet process was chosen may have been that the Czechs who are the suppliers reportedly do not produce dry process plants.

Equipment. All necessary equipment has been provided except a bag plant, which the suppliers state is not available from Czechoslovakia.

As a result of good planning, many units in the plant are adequate for double the present rated capacity. To accomplish such an increase a second kiln would be needed plus additions to raw material and finishing cement grinding capacity. Additions to the power generating capacity would also be required. The expansion should be economical when needed.

The power plant consists of six generators of 950 KYA capacity, of which five have been installed. The sixth, on temporary loan to the Central Makassar power station, will be installed shortly. There is also one 450 KVA emergency generator. The plant's total power requirements is 3,800 K and will be fully supplies by the 6 generators with stand-by protection. The power sta- tion was supplied by Skoda. The cement-making portions of the plant were sup- plied by Techno Export. An unusual clinker cooler is used rather than the conventional Fuller clinker cooler.

Project Cost. 1) The Czech equipment credit is for b1.7 million. 2) Prior to 1967 local currency amounting to Rp. 36 million had been spent and Rp. 18.5 million expended in 1967. An additional Rp. 131 million is needed to finish the project by July, 1968. 3) Upon completion of the project the plant will be valued at $11.5 million which computes to a high cost of $96 million per annual ton of installed capacity. 4) In addition to these costs the access road is under water for limited periods during the rainy season and may have to be raised one meter at a later date which will prove expensive. At least $75,ooo worth of trucks will have to be bought as discussed below. - 61 -

At.some future date it may prove advantageous to proceed with plans for a harbor in a nearby river to reduce transportation costs. The plans comprise dredging of the channel, construction of a pier, and installation of fuel tanks. But these additions can be postponed for some time and perhaps even until the plant capacity is expanded. 5) Working capital required is Rp. 133 million.

Technical Assistance. The Czechs guaranteed the output of the plant and the oil and power consumption per ton of product. Czech erectors are at the site and a new Czech crew will arrive to supervise start-up. No continuing technical assistance is expected to be required in view of the experience acquired in the operations of the existing cement plants at Padang and Gresik.

The civil work has been performed by Indonesian project personnel.

Spare Parts. The equipment contract included 3 - 6.months spares. However, over the long construction period spares have been used up as well as pilfered.

A current inventory of spares is being taken with the view to immediately reordering an adequate quantity. In addition, because Makassar is in a remote area, inventory of spare parts should be higher than normal. As an example, there is an850 KW motor on each of the two mills; a spare motor is essential should failure occur and rewinding become necessary.

Trucks. No provision has been made on this project for the necessary trucks required to haul fuel oil, gypsum, cement bags and other supplies from Makassar to the plant site at Tonasa. Also, of course, the cement must be hauled out of the plant. The management is hoppful that consumers will lift the cement at the plant in their own trucks. Even if this proves to be practicable it makes no provision for the 66-2/3% portion of the production which it is expected must be shipped through the Port of Makassar to other islands.

Materials.

1) Limestone is obtained from quarries adjacent to the plant site and clay is available nearby. Gypsum will be imported. 2) Fuel oil must be hauled to the plant from the oil depot at the Makassar harbor. Presently the depot has tankage for H. S. diesel oil but not for the industrial diesel oil which costs 50% less. At Tonasals consumption rate the difference is Rp. 50,000 daily. Appropriate ministerial levels in Djakarta should persuade Pertamin to make available or install the necessary additional tankage for this cheaper fuel. - 62 -

3) Until a bag plant is installed the bags can be purchased from Gresik near Surabaja which fortunately now has surplus capacity.

Selling Prices and Profitability. The management forecasts an average ex-factory price per bag excluding sales tax of Rp. 215 per bag, which is equivalent to $28.60 per ton. The production cost is estimated at Rp. 159/bag or $21.20 per ton. The difference of Rp. 56 is taxable profit but the company is hoping for a five-year tax holiday.

With operations at 95% of rated capacity the company expects to make a pre-tax profit of Rp. 128 million after depreciation of Rp. 86 million which is taken on a 5% per year straight line basis on fixed assets of Rp. 1.72 billion. The pre-tax profit of Rp. 28 million represents only 7% return on total assets.

The company expects stiff competition from imports and from Gresik in both the Surabaja and Djakarta markets. Tonasa's competitive position is apparently satisfactory in Bali, Kalimantan, West Irian, etc., but cement consumption levels there are low.

It will require careful market planning and excellent salesmanship if these sales goals are to be attained. It is urged that competent marketing personnel be employed.

Management. The management at Tonasa seemed vigorous and adequately motivated. They made a good impression and were well aware of the problems facing them.

Recommendations. The mission recommends that:

1) The purchase of the proposed bag plant be postponed until 1969 and when purchased be of the type and manufacture now installed at Gresik and Pusri and of a size adequate to handle 240,000 tons of cement annually. This recommendation is based on the following:

a) The amount of loan capital available to Indonesia is limited. b) The Gresik cement plant has (and will have until its own expansion) adequate surplus bag-capacity and has supplied samples of acceptable bags. c) The Tonasa staff has sufficient burdens with cement plant completion and start-up to justify postponing the bag plant. d) The Tonasa plant will probably not operate at capacity in the first 12 months which is now scheduled to commence in July 1968. - 63 -

2) Instead of including the bag plant in the 1968 program sufficient trucks of proper type (both regular and tank) preferably with trailers should be acquired to assure the economical movement on multiple shifts of raw materials and supplies in-bound and cement out-bound. A provision of $75,000 for this purpose is urged.

3) Sufficient rupiahs should be provided on the required schedule to complete this plant particularly in view of the short-fall of rupiahs in 1967.

4. P. N. SODA - WARU, SURABAJA

The mission visited this project to discuss the possibility of rehabilitating the plant to reach original design capacity and to compare the costs and advantages to another proposal to instal a caustic-chlorine unit at the new paper plant being erected at Banjuwangi. The latter project was also visited and it is discussed below. The Plant

Capacity. The designed capacity of P. N. Soda is 3,000 tons of caustic soda, 3,000 tons of hydrochloric acid and 3,000 tons of bleaching powder. Up to 3,600 tons of chlorine can be liquefied if production of hydrochloric acid and bleaching powder are correspondingly reduced.

Equipment. The plant was built with Japanese reparations and commenced operations in 1956. Krebbs cells were installed together with a diesel generating power plant using mercury rectifiers to produce direct current. The equipment is somewhat unbalanced.

Operations. The raw material for the plant is salt produced extensively in the area by the natural evaporation of sea water. It has not been possible to date to operate the plant at capacity owing to the impossibil- ity of selling all the chlorine that would be generated at a capacity level in any combination of chlorine, hydrochloric acid or bleaching powder. Further- more, the plant is located in an industrial area and cannot vent the surplus chlorine. As is so often the case in a developing country, this caustic soda-chlorine plant has therefore been operated at the production level dictated by the possibilities of sale for chlorine-containing products. The output of caustic soda which is co-produced had to suffer despite large domestic consumption and corresponding imports. This relation of production of caustic soda (Na0H) to imports is shown by the following table: - 64 -

Metric Tons Metric Tons Na0H NaOH Year Production Imports

1956 263 19,000 )

1957 573 19,000 ) average 1958 947 19,000 )

1959 820 22,644

1960 750 6,029

1961 985 13,266

Unfortunately later precise data were not available. However, information at hand is adequate to show that while the Soda Waru plant has continued to operate at about 33% of capacity, sizable quantities of caustic soda have been imported consistently. Indonesia's needs under conditions of free availability of foreign exchange, normal credit facilities and improved economic conditions are variously estimated as high as 73,500 metric tons annually.

This low level of operations and of corresponding income has naturally postponed improvements to increase efficiency and the level of maintenance has al;o suffered.

Fortunately, the staff is well experienced in this specialized chemical operation and highly motivated to convert P. N. Soda into a successful and profitable enterprise.

Rehabilitation. A rehabilitation and debottlenecking of Soda Waru to bring production to design capacity can, it is estimated, be accomplished for not more than $750,000. While this sum is almost double the Banjuwangi request which appears low, the incremental increase in chlorine production is more than three fold.

This program should be performed in two stages with the first stage to be completed by November 1968 to assure adequate supplies to Banjuwangi before the latter's scheduled start-up as well as to existing customers.

The second phase is scheduled to be finished in mid 1969.

This program will require the purchase of numerous replacement parts and various supply items. The company is expediting the preparation of the list of parts and supplies so that orders may be placed as soon as the credit is established. The basic plant was supplied by Japan. - 65 -

Market. The increase in production of caustic soda from 1,000 to 3,000 tons annually should move readily into existing trade channels.

The sales of chlorine will be more difficult and will require considerable sales and product development. The mission feels that exploration of the following areas and collaboration from other governmental and private enterprises will produce a basis for continuous production at designed capacity with corresponding benefits to the Indonesian economy:

1) The city of Surabaja is equipped to use either chlorine or bleaching powder in its water purification plant. Because chlorine is cheaper for the city and more con- venient for Soda Waru to produce, it is recommended that the city switch to the use of chlorine.

2) The City of Djarkarta imports its bleaching powder for water purification. Efforts should be made to persuade the city to purchase from Soda Waru.

3) All other cities should be actively canvassed for sales of chlorine or bleaching powder for use in water purification.

4) Paper plants should be visited to determine the possible need for chlorine above their own captive production.

5) The appropriate authorities in the Department of Estates should be requested to confirm that ammonium chloride is an acceptable nitrogenous fertilizer. In other countries this product is widely and successfully used. If the Department of Agriculture agrees, the Director General of Chemical Industries should be requested to install suitable tankage and reactors at the Petro-Chemical complex at Gresik, which is now under construction, to convert there any surplus chlorine from Waru into ammonium chloride.

Recommendation. It is recommended that a sum not to exceed $750,000 in foreign 9xchangETElocated to P. N. Soda Waru for rehabilitation and modernization provided the Indonesian Government makes available the requisite rupiahs for installation and repair. - 66 -

5. PAPER PROJECT BANJUWANGI - BANJUWANGI, EAST JAVA

The purpose of the visit was to investigate the need for a caustic- chlorine unit estimated to cost $400,000 and Rp. 201,000,000. This is also a new project and therefore merited considerable attention by the mission.

The Plant

Capacity. 9,000 tons/year of writing and printing paper.

Description.

1) The equipment has been supplied by Toyo Menka Kaisha of Japan, under reparations.

2) Equipment includes:

a) Power generators: 3 X 150 KVA, 1 X 250 KVA b) Water treatment plant c) 30 ton/day pulp mill - 2 digesters d) Paper mill e) Chemical recovery plant f) 15 fuel tank trucks - 25 bamboo transport trucks.

Project Cost and Completion.

1) Plant and equipment $5.9 million Construction material 1.5 million $7.4 million

2) Rp. 200 million additional are required to complete the project and this is to be made available from the 1968 budget.

3) Working capital of Rp. 80 million will be required when the mill commences operations.

4) Plant construction started in March 1964 with completion scheduled for September 1967. However, the project is running one year late because of the lack of rupiahs at various times during the construction period. The new estimate of completion is September 1968.

5) In 1967 Rp. 50 million had been promised for construction purposes but at the time of the visit only Rp. 22 million had been received. P.I.Peprida, a state construction company, is the main contractor. Because of the rupiah shortage, it undertakes the work in segments each carried out only when rupiahs are received. Each segment is performed under a separate fixed price contract. - 67 -

Technical Assistance

1) Japanese equipment suppliers sent an erection team. It is reported that cooperation has been good and Japanese supervision effective. 2) Upon completion of construction and installation of equipment the Japanese will send a special start-up team.

3) Output of 30 tons/day of writing and printing paper has been guaranteed together with the consumption level of power and chemicals. The test run and take-over terms are as follows:

a) Plant will be brought up to guaranteed capacity within three months after start-up,and b) Must produce 30 tons/day for three months to be accepted by Indonesians.

h) Fifteen Indonesians have been sent to Japan for one year's training. However, because no bamboo-based plants operate in Japan, the experience is not directly applicable in all cases to the Banjuwangi plant requirements.

5) The management is considering at least a one-year contract for operating assistance either from the Japanese suppliers or a Japanese paper producer.

Project Status

1.) The power plant and workshop are completed.

2) The water treatment plant will be tested in a month's time. 3) The recovery boilers are installed.

4) The digesters are being built and the equipment,virtually all delivered p is ready for installation. Almost all of the civil works have been completed.

5) The plant layout is good and should permit efficient flow of materials. Sufficient room has been left for expansion. Raw Materials

1) Bamboo is to be provided from a 12,000-hectare forest area located from 15 KM to 60 KM from the plant site. An area of 9,000 hectares in this forest has been reserved for the Banjuwangi project. Fifty per- cent of the forest is pure bamboo and the remaining 50 percent is mixed bamboo and other growth. This 9,000-hectare reservation appears to be on the low side when compared with the expressed needs of the Gowa plant of 2,000 - 3,000 hectares of bamboo per year for the same level of paper production. - 68 -

On a basis of four-year regeneration and an average annual need of 2,500 hectares, the area reserved should be 10,000 hectares. Reserving 10,000 out of the available 12,000 hectares of forest area would appear to preclude future expansion at Banjuwangi unless another raw material could be used or other accessible bamboo forests made available.

The cheapest method of harvesting is said to entail the cutting of the entire clump and then permit the bamboo to regenerate itself. After four years' growth it is again ready to be cut.

2) The State Enterprise for Forestry is in charge of the reserve and will enter into a contract with the paper plant to supply bamboo. The paper plant has built the road to the reserve but.the forestry company is expected to build the roads within the reserve. So far it has built 20 KM of road, which is sufficient for exploiting the areas nearest the plant. An additional ho - 50 KM of roads will ultimately be needed. Bamboo supply for two years is assured even if no additional investment in roads is made immediately. The bamboo reserve is estimated by the project officials to be good for eight years without replanting.

3) The forest contains 8 - 10 species and even though they have been known to flower from time to time the clump is said to survive. There- fore flowering is not expected to be a problem. This aspect would appear to need further investigation since flowering has caused serious losses of available bamboo elsewhere.

4) In order to bring out the bamboo, the project has 25 trucks. Each truck makes two round trips per day carrying four tons each trip. Consequently 15 trucks carrying eight tons per day can supply the 120 tons of bamboo needed per day.

5) In another nearby area Directorate General of Forestry is plant- ing 300-500 hectares of pine each year. Currently it has 1,500 hectares of 15 year old pine. In 10 years the Banjuwangi plant may switch over to pine.

6) The basis for payment for bamboo is a problem. The forestry company cannot guarantee moisture content. The paper project wants to accept bamboo with no more than 30% moisture but young bamboo has up to 60%. It wants to base the price on dry bamboo but determining the average moisture content is a problem.

The current practice is for the forestry crews to cut the bamboo and haul it to a central storage area for drying. It is later picked up at that point by the trucks of Banjuwangi mill. This involves double handling, larger inventories, etc. While this procedure may be the cheapest alternative to prevent the trucks hauling high moisture content, this matter needs care- ful study. It may actually prove cheaper to have the paper company do the cutting and directly load trucks for delivery to the plant. A simplified and accurate basis for payment for bamboo could then be instituted based on Banjuwangi's pulp output records. This method would also eliminate the possibilities for misunderstandings between the parties. Negotiations on this possibility are in progress. - 69 -

Chlorine and Caustic Soda

The paper project requested funds to install its own electrolytic cells for the production of chlorine and caustic. Original plans called for Soda Waru to provide this chlorine. However, Soda Waru was delayed in its rehabilitation by lack of foreign exchange and therefore a self-contained plant was proposed.

After discussions with the mission, all parties agreed'that Soda Waru should provide the chlorine.

The chlorine can be transported either by rail or truck to Banju- wangi. In the case of a truck, it can make a round trip to Surabaja in two days and with one trailer can carry eight tons. Banjuwangi's needs are 2.3 tons per day. Therefore, one truck and trailer can cover the transportation needs. Fifty chlorine cylinders have already been purchased so that 15 one- ton cylinders can be maintained in plant inventory at all times. The remaining cylinders would, of course, be at Soda Waru or in transit. Com- parative advantages and costs of shipping by rail are being studied.

Fuel

There are 15 tank trucks on hand scheduled to deliver fuel to the plant from Surabaja in late 1968. Actually the fuel can be transported by rail or perhaps even by tug and barge. These trucks could be made available temporarily to Pertamin on a lease basis or outright sale. When needed by the plant Pertamin can replace them with new trucks. It seems wasteful to allow them to remain unused.

6. TIRE PROJECT - PALEMBANG, SOUTH SUMATRA

The mission membersv'ere acquainted with this project through an earlier visit in 1966.

This plant has had a trying career and is finally to be completed 1with the installation of additional and vitally needed equipment recently supplied from West Germany under a new credit.

The two installed diesel generators will barely provide sufficient power for capacity production. A spare diesel set (560 KW) with accessories is requested and is recommended by the mission in the amount of $113,000. - 70 -

7. SALT STATE ENTERPRISE-MADURA

This organization is engaged in the production of salt by the natural evaporation of sea water. It is one of the principal industries on the island of Madura.

In recent years independent entrepreneurs in eastern Java have entered the salt business on an increasing scale and have captured the large markets of Surabaja and surrounding areas forcing the State Enterprise on Madura to transport its production to more distant points in the islands.

Because of high corrosion rate shipowners are unwilling to lease their ships and barges for this service which forces the enterprise to request aid in the amount of $500,000 to rehabilitate its own fleet.

The mission recommends the requested $500,000 with related rupiah expenditure.

8. TIN MIINIG

Tin production has been declining and the industry is now operating at a fraction of its capacity. Equipment as well as management improvements are required. The mission visited operations on the island of Bangka.

Tin Reserves and Output

Total proven reserves are reported to be 235,000 metric tons of tin with the probable and possible reserves substantially larger. This would be 15 - 20 years output at the present level of production. The problem is tin content rather than overall extent of reserves.

There are ore reserves on three untouched land areas each with ten years of proven reserves at the operational rate of a new modern dredge. Additional sea dredges can also be wisely used to exploit new offshore deposits.

The grade of tin ore has gradually reduced from 9.73 kg./m3 to 0.44 kg./m3 in the last twenty years and the decline is continuing as the richer areas are worked out. In January 1967, 2,266 tons of tin were produced from the dredging of 4.11 million cubic meters, which is an over- all average for that month of 0.5 kg./m3 . For planning purposes it is estimated that a conservative over-all average would be 0.3 kg. of tin per cubic meter of earth under present conditions. However at the current high tin price of $3,000 per ton, it is profitable to work areas containing as low as 0.15 kg. of tin per cubic meter. - 71 -

Despite the decreasing quality of the ore to an expected average of 0.3 kg. of tin per cubic meter, the dredging of 50 million cubic meter of earth and the resultant annual production of 15,000 tons of tin on the island of Bangka appears attainable.

The attainment of this goal is vital to Indonesia in its search for foreign currency earnings and important also in retaining its position as a substantial supplier of tin to world markets.

The early achievement of this goal will require the rehabilitation of, and maximum production by all existing dredges augmented by several new ones with each new one expected to pay out in less than three years and the rehabilitated ones earlier.

Dredge Capacity

Current dredging capacity is 33 million cubic meters per year with 18 dredges. The dredges on an average are operating at about 60 percent of capacity. In order to reach the target of 15,000 tons of tin for Bangka, dredging capacity needed is 50 million cubic meters. To reach this capacity, approximately eight more dredges would be required with each dredge having a capacity of 2 million cubic meters per year.

Dredge Rehabilitation

The complete rehabilitation of all equipment - dredges, electric and hydraulic mines, central power station and some roads - will cost $17 million for the island of Bangka alone. The staff has prepared a compre- hensive program of costs, timetables, reserves by mining areas and increased profits from a broad rehabilitation program. The incremental earnings from the increased production supports the estimated expenditures. Aid in the amount of $3,250,000 was requested for 1968 for the rehabilitation of five dredges with the required rupiahs to be furnished by the company from its own earnings.

To illustrate the problems connected with the rehabilitation of dredges, the mission observed rehabilitation operations in progress. One dredge, the "Tempilang" (of 9 cubic feet capacity), was "dry-docked" by building a temporary dam and pumping water out, leaving the dredge on jacks. The other was operating in an old tailing pond initially dredged by the Japanese. The "Tempilang" was dry-docked in November 1966 for replating and overhaul. This overhaul, which should have been completed in six months, is now scheduled to be finished by January 1968, i.e. in 15 months.

Because the "Tempilang" is a sea dredge operating offshore, the corrosion by sea water was severe. So far 300 plates had been replaced which accounted for 70 percent of the rebuilding work. Numerous supporting beams and bulkheads had also corroded and are being replaced. - 72 -

All pumps, generators, engines are also being overhauled. A simple workshop had been set up nearby with lathes, drill presses, shears and a sheet rolling mill to shape plates and sheets. This shop refurbished the bearings and performed the usual work on pistons, valves, etc. The main- tenance crew appeared capable.

The boilers could not maintain sufficient pressure for capacity operations when the dredge was dry-docked. There was considerable difficulty in obtaining parts for the steam engines which were built before the War, and proper maintenance is becoming increasingly difficult and expensive. The staff doubts that full output will be achieved even after this extensive overhaul and long down-time.

Adequate supplies of materials, particularly welding rods, were difficult to obtain and slow in arriving. The welding machines were old and not functioning properly. All this delayed the replacement of plates. These difficulties could be traced directly to the lack of rupiah financing.

Another dredge visited was of 9 cu. ft. capacity. It was producing approximately 20 tons of tin per month. The ore, cassiterite, was concen- trated to 58 percent tin because greater concentration would have lost too much tin. The concentrate is then sent to a washing plant where the concen- tration is increased to a minimum of 70 percent and is then ready for ship- ment to the smelter.

At the time of the visit the dredge was operating in an area having a tin content of 0.2 kg. of tin per cubic meter. While this is a relatively poor area, the staff reported that areas with even a 0.15 kg. of tin per cubic meter content could be profitably worked.

The staff recommended and the mission agrees that all the steam- driven dredges should be converted to diesel electric. One such conversion is now being completed and each conversion will cost about $600,000 for equipment. The staff to carry out the conversion is already on the payroll.

The reasons for the conversion are:

(1) Breakdowns will be reduced and hours of operation increased; (2) With no parts available, some of the steam-powered dredges may soon become inoperative; (3) Conversion is considerably cheaper than the cost of new dredges; (4) The efficiency of the steam-powered dredges is very low. - 73 -

Recommended Program

Rehabilitation. The mission recommends that a larger program in the field of dredging equipment should be undertaken than that proposed above. A comprehensive program should be established to rehabilitate all existing eighteen dredges at the rate of four per year at a total cost of $12,150,000 and with $2,700,000 disbursed in 1968.

A comprehensive program would assure (1) standardization of procedures increasing speed, decreasing cost and decreasing loss of tin production, (2) standardization of equipment, diesel generators, pumps, etc., thereby lowering costs, decreasing spare parts inventory, speeding maintenance and decreasing out-of-service time.

The program would stop the forecasted annual decrease of 10 percent in tin output, and upon completion of rehabilitation, increase production by 4,000 annual tons above current levels valued at $12 million. Adding a rupiah cost equivalent of $3.5 million for a total of $15.5 million, the program pays out in less than two years. This higher production level should not require any added personnel.

New Dredges. The purchase of two new modern dredges should be authorized to operate in two of the existing untouched proven reserves of 10 year minimum life at a total cost of $8 - $10 million disburseable in 1968. A payout period of less than three years is indicated.

The immediate purchase and operation of these new dredges has the advantages of (a) maintaining earnings at or above current levels despite the withdrawal of the old dredges for rehabilitation, and (b) the new dredges can be placed in operation with little or no rupiah outlay for local expen- ditures at a time when rupiahs are short.

The mining company will provide from its earnings all the rupiahs required to import, install, repair and rehabilitate the new and old dredges.

Exchange Rate and Income. At the present time the Tin Company receives 75 percent of the foreign exchange sales revenues with the Govern- ment retaining 25 percent. Out of its share the company pays an additional .3percent to a Government corporation as a management fee and a further 1 percent to the Department of Mines. In the case of other minerals the split is 90 percent to the company and 10 percent to the Government, and it is hoped that a more favorable ratio may be applied to tin.

Of the 25 percent of revenues retained by the Government, a portion 10 percent - goes to the provinces for maintenance of roads and services. Bangka, which is included in the province of South Sumatra, has received no allocation from the Provincial capital of Palembang for several years. The roads and particularly the bridges are in deplorable condition. - 74 -

The net retained revenues at the company level have been expended for operating expenses, exploration, completion of smelter, etc. Rehabilita- tion of equipment has suffered and in fact expenditures on exploration have been subnormal because this level of retention is inadequate and operating costs are high.

Smelter. The tin smelter at Mentok has been under construction since 1961 and has not yet operated successfully. The foreign currency capital requirements have, it is reported, already been paid in cash. Delays in rupiah availability slowed or stopped construction for varying periods.

The plant is being constructed on a cost-plus-fixed-fee basis under the design and engineering supervision of Kloeckner-Humboldt, a well-known West German manufacturer. It is understood that the process contains some novel features, one of which is a rotary smelter unit instead of the customary stationary unit. In the initial test run several months ago, the refractory brick lining of all three smelting units failed after a few days operation and the plant has since been inoperable.

This failure has necessitated the selection of a different refrac- tory and the manufacture and installation of complete new linings. The new brick has arrived and is being installed; the German technicians are return- ing; and itvasplanned to recommence operations early in November 1967. It is hoped that the new refractory brick will solve the problem and assure con- tinuous operations. The balance of the equipment has operated satisfactorily.

The construction delays and the smelter difficulties have cost the company dearly. They estimate a loss of 4 years smelting income of approxi- mately $2 million annually. They have also incurred a loss of one year's interest charges on $8 million of immobilized concentrate inventory. With a normal uninterrupted construction schedule and a trouble-free start-up, the total cost of the plant at approximately $6.5 million would already have been paid out.

Development aid in the amount of $694,000 and Rp. 97,500,000 has now been requested by the smelter. It is proposed to erect oil storage tanks, complete a machine shop, construct improved harbor facilities, and pay the balance of consulting costs.

The mission considers it vital that tankage be constructed, in which to store the fuel oil requirements of this oil-fired smelter. The present makeshift practice of bringing barges from Palembang and pumping through the plant is uneconomical, a fire hazard, and could create work stoppage through inadequacies of supplies. Since the company is called upon to provide almost all the services on the island, they are the source of kerosene supply for the workers and other citizens. A tank for this commodity is also essential. A third tank is needed at the refinery for gasoline supply. The foundations for the oil tanks are installed and small tankers of Permina can conveniently anchor off the nearby breakwater wall for dis- charge without necessitating the completion of the harbor. A porion of the dollar element and much of the rupiah portion requested are for the dredging of a 700 meter channel and the construction of a wharf. The mission does not believe that this work should be under- taken at this time for these reasons:

(1) The money could not be spent and the work completed in 1968. (2) The concentrate is presently collected from the producing points on Bangka, Belitung, and other islands, by barges and tugs owned by the company. These barges can be conveniently unloaded alongside the existing break- water and trucked into the smelter storage. (3) The outgoing tin ingots can be barged out to an ocean- going liner standing a short distance offshore. (4) Dredging of a much more important nature is backed up at other harbors of Indonesia for lack of dredging equipment and should take priority over the require- ments here at Mentok. Recommendation. It is recommended that $95,000 of aid with requisite rupiah financing be provided to cover the limited expenditures necessary for technical service and to purchase steel plate to be rolled at Barata in Surabaja for the requisite tanks.

Power Plant. Aid in the amount of $3,429,000 was requested for the power plant at Mantung supplying the tin smelter. Rp. 450 million are to be provided from company's funds.

The aid request entailed (1) a new boiler of 55 tons/hr. capacity to replace the three in operation which are from 40 - 60 years of age; (2) a new turbine which would permit taking each of the other three turbines out of service consecutively and overhauling them to make operation at 400 lbs. per sq. in. pressure possible; (3) the spares and equipment to accomplish this overhaul.

Recommendation. The mission recommends a much more limited alternative program. It is suggested that the broad aspects of this pro- posed rehabilitation of the power generating facilities be postponed for two or possibly three years because the need is not imperative and because the sum of money required could, in the opinion of the mission, be spent better in this period on productive equipment as explained above.

The purchase now of a new boiler of the standard package type is fully warranted as protection in view of the age of the existing boilers. This plant, the only power facility on the Island of Bangka, supplies the requirements for the entire mining activity of the island as well as the electrical needs of the island. The mission believes such a unit can be purchased for approximately $500,000 and supports this amount of aid to- gether with the attendant rupiah expenditures. The remainder of the $1,000.000 is recommended for the electrification of the mines. - 76 -

The mission understands that an old contract is pending for a boiler and other items which was never validated due to lack of funds. It is suggested that this previous approach be ignored and a new start be made since much progress has been made in recent years in the development of "package boilers" with relatively lower capital cost per unit capacity and greater efficiency of operation. This expenditure can be committed and expended in 1968.

Slipway. The mission also recommends that an additional slipway be constructed to permit the simultaneous rehabilitation of two dredges each six months. The approximate cost would be $500,000 disburseable in 1968.

9. PUSRI FERTILIZER PLANT

The support of agriculture has wisely been assigned a high priority and serious consideration has therefore been given to the early expansion of the Pusri plant at Palembang which has been profitably producing urea at the designed capacity of 100,000 tons a year. To this end the Directorate General of Chemical Industries and the staff of the Pusri plant have completed engineering studies with cost and profit calculations based on alternate expansions of 100%, 200% and 300%.

The level selected will be directly related to the availability of natural gas in the area. At the higher levels of expansion the product costs would permit selling prices directly competitive with the most attractive world prices presently offered. The Pusri plant, according to these studies, would be able to generate the required rupiahs to cover local construction and installation expenditures and to provide for debt retirement.

While a careful forecast of Indonesia's future fertilizer needs is being prepared, it is certain that these needs when determined will exceed the combined production of Pusri even when expanded 300% plus the ammonium sulphate and urea output of the petrochemical complex now being built at Gresik.

In cooperation with the oil companies a survey of natural gas supplies is being made. Based on preliminary studies it will doubtless be necessary to install an additional pipeline and collecting lines; these costs must of course be included in the project. It is probable that boiler fuel can be converted to fuel oil to release more gas for use as processing feed stock.

Because of the many basic services available the proposed expansion can be accomplished economically and it is therefore logical to consider expanding Pusri to the maximum limit of available gas supplies. The large importation of fertilizer justifies an early start on this expansion. As indicated above, most of the technical and economic studies have been com- pleted and are favorable. - 77 -

Recommendation. The mission recommends that this expansion of Pusri urea production with a probable foreign exchange cost of $50 million be authorized and coverage provided for the 1968 disbursements of $1 million for engineering provided that this expansion is consonant with the results of the study on future mixed fertilizer needs recommended elsewhere in this report.

10. FOURTH KIIN CEMENT PLANT - GRESIK

The mission suggests the addition of this expansion to the list of development projects and that $500,000 can be disbursed in 1968 out of a total commitment of some $2 million. The capital cost is expected to be relatively low because most of the ancillary equipment in the basic plant possesses surplus capacity.

This plant has already been installed and is operating three of the four kilns for which provision was made in the original plant design. All production is readily sold and total domestic output is substantially less than requirements. With over 95% of indigenous materials and labor in the product, it would appear unwise to delay further the installation of this fourth kiln.

A current review of limestone reserves at the company's disposal are nearing completion and is expected to confirm earlier forecasts of raw material adequacy.

The company is well managed and profitably operated. It needs this additional production to maximize returns from the expenses originally incurred to provide for this eventual expansion and from the broad infra- structure which it was required to install.

11. & 12. SPINNING MILL and POWER UNIT MAKASSAR (GOWA) SOUTH SULAWASI

The basic justification for this project is to provide a better balance between spinning and weaving in the Indonesian textile industry. The request for aid for this project was $4. 6 million with an added Rp. 100 million required for installation costs.

It was originally expected that the equipment for this spinning mill of 30,000 spindles would be obtained under a credit (now cancelled) from Mainland China sufficient to cover also an identical mill for Padang in Central Sumatra. - 78 -

Because weaving on hand and machine looms is widespread throughout the Archipelago and because the raw cotton must be imported, it has long been planned to construct spinning plants of this size at appropriate locations. Several such mills have been erected and are operating.

At Makassar, in the Gowa area, a suitable site has been acquired and cleared. Prior to the cancellation of the China credit a temporary storage building had been erected.

While the mission accepts the fact that there is an ultimate need for two spinning plants (Makassar and Panang), it was compelled to decline to support both of them in the 1968 aid program because the development segment of this program was intended to cover a transition period in which foreign aid and correlated rupiah financing would be made available for projects under construction or requiring correction or rehabilitation. The spinning mills were in effect "new" projects.

It was recognized however that the substantial time required for project development, equipment delivery and construction of well founded industrial projects justified consideration of some commitment in 1968. On this basis and to this extent the Makassar project was selected and the Padang mill postponed without prejudice until a subsequent credit can be arranged.

As mentioned elsewhere in this repo-t, the mission recognizes that self-contained power generating units at each industrial plant are not generally a wise use of capital. However, the transmission systems in most locations are inadequate, even if generation at a central station were adequate.

Such is not the case in the Gowa area of Makassar. A new power plant is under construction at Makassar with provision for the installation of additional generators to double the capacity. Furthermore, a transmission line exists and will be amplified to connect into the system the surplus power available at the paper plant in Gowa. Fortunately, the site of the proposed spinning mill is nearby.

Recommendation. The mission recommends, therefore, that US $1 million to cover disbursements in 1968 be provided under a total credit of ,US $4 million (instead of the $4.6 requested) for a 30,000-spindle spinning mill at Gowa-Makassar, with additional credit of US $1.6 million to the Makassar power station for doubling its generator capacity (two additional duplicate generators) by the end of 1969 to cover the power needs of the spinning mill and other requirements. - 79 -

13. BANJARAN SPINNING MILL

A request for aid in the amount of $200,000 together with local currency needs of Rp. 14 million was made to purchase and install a temper- ature and humidity control system at this spinning mill.

To attain maximum production and proper yarn quality, the system is required and the mission therefore recommends the project.

14. COAL MINES

A request was made for aid in the amount of $143,000 for the Ombilin Nine and $330,000 for the Bukit Asam Mine.

The money was intended in each case for the rehabilitation of underground equipment and loading facilities to keep the mines operating thereby assuring continued employment of the 7,000 miners.

While the trend to diesel oil was acknowledged, a fervent hope was expressed that some new profitable mine could be discovered, developed efficiently with foreign investment, the old mines closed and the 7,000 workers transferred.

This condition raised a number of unanswered questions. Will the internal price of petroleum products be raised to the world price level reducing the present unreasonable price advantage of oil over coal? Or will equal subsidy be granted to coal? Will State corporations having provision for the use of both oil or coal in their power plants be permitted to change to oil? Will the State railways be given sufficient funds so that they can pay their reported three year indebtedness to the coal mines making it possible for the mines to resume coal shipments for steam locomatives?

Obviously the resolution of these and other problems will affect theeconomics of any rehabilitation at the mines. Because a compelling justi- fication for the rehabilitation was not obtainable, the mission recommended that the request be denied until the above-mentioned disabilities are rectified and questions answered. APPENDIX 2

RETARDED PROJECTS

1. IRON AND STEEL PROJECTS

1. The mission visited the steel project at Tjilegon on October 27. The retarded steel project at Kalimantan and the pig iron project at Lampung were not visited but will be touched on in this report.

2. The Tjilegon project has been in suspense for about 2½ years and presents a depressing sight. The financing was secured from the U.S.S.R. It was to be a steel producing enterprise starting with pig iron and scrap.

3. The design capacity at Tjilegon is 100,000 tons annually of rounds, bars, nail wire and other wire. To attain this capacity, it was planned to operate the wire plant one shift, the rolling mill two shifts and the balance three shifts. The capacity may prove to have been con- servatively stated. For example, the rolling mill could be operated three shifts using purchased billets if the planned open hearth furnaces could not deliver-adequate quantities. In that case the output would rise to at least 150,000 tons annually.

4. The feasibility study was made by a Russian Study Team which selected the site and designed the mill. A proposal with available credit at 22- percent interest was offered and accepted. Indonesian engineers and technicians were not phased in very deeply during either the study stage, the project review or the material inspection at source. The original cost of the equipment as proposed was U.S.$ 36 million. This sum was subsequently raised to U.S.$ 38.5 million aE a result of revisions in the specifications. About 80 percent of the equipment has arrived worth $29,106,837, of which 5-percent has been installed. To date, the Indonesian Government has in- vested the rupiahs equivalent of $8,027,000 in site clearance, infra-struc- ture and buildings.

5. In view of the cost, it is important to keep in mind that this project was designed to accomplish much more than the construction of an iron and steel plant. It represents an area development of considerable magnitude including:

1. The development of a small harbor having an 800 meter quay with draft at wharf of 30-35 feet. A dam at one end and two breakwaters at the other were planned to produce a well protected harbor which included a fisheries area. This harbor - 9 km. from the plant site - would serve the plant and also the general area.

2. A thermal power plant of 38 megawatts capable of using either coal or oil. This capacity is far in excess of present mill requirements and is also designed to supply the power require- ment of the area. - 81 -

3. A 40 km. water pipeline adequate to supply the plant requirements including power plant, plus the irrigation water for agriculture - principally rice - and the potable and sanitary water needs of the area.

6. To complete the steel mill and power plants as designed will, it is estimated, require the expenditure of Rp. 2 billion ($13.3 million). The mission estimates that about U.S.$ 2-3 million additional may be necessary in foreign currency to cover replacements due to pilferage, disintegration and corrosion.

7. With so much money spent and so much time lost, it probably serves little useful purpose to try to allocate infra-structure costs between area development and the steel mill. However, the completion of the water pipe- line, harbor, pier, balance of housing, etc. is certainly area development and it may be of some value to note that the cost is estimated at $2.5 million in foreign currency and about Rp. 2 billion ($13.3 million).

8. Some of the infra-structure is certainly attributable to the steel plant. On the other hand, area development weighed heavily in site selection which has without doubt penalized the steel plant cost-wise.

9. From these data the apparent estimated cost for the plant is:

Plant equipment as contracted $38,500,000 Plant equipment required for completion 3,000,000 Government expenditure for local expenses 8,027,000 to date Local expenditures to complete 13,333,000

Total: $62,860,000

Thus the capital cost per annual installed ton at design capacity is U.S.$ 628.60 a ton, or capital cost per annual installed ton at probable demonstratable capacity 62,860,000 = U.S.$ 419.00 150,000 10. It must be remembered that, despite this high cost, the plant was to operate from pig iron and scrap with no iron-making equipment. It produces only rounds, bars, simple shapes and wire but no flat products.

11. Certainly this capital cost represents a very heavy amortization schedule for such a small mill to carry and will adversely affect production cost and profitability for many years. 12. The mill and ministry staffs have tentatively estimated that they can operate the mill if and when completed on a feed stock of 30 percent pig iron at $60 per ton and 70 percent scrap at $25-$28 per ton both delivered at plant site. - 82 -

13. On this basis, an estimated plant cost of $100 a ton for bars and $120 a ton for nail wire is arrived at. The former would net a small profit when sold at the import price of $120 a ton.

14. The annual generation of profits - (120-100)xlOO,000 tons is indicated at $2,000,000. At a monthly production rate of 8,000 tons, there will also arise a need for working capital, not otherwise provided, of:

6 mos. supply of pig iron $60 x 14,400 tons x Rp.150/$l Rp.129,000,000 3 mos.supply of scrap $25 x 16,800 tons x Rp.150/$l 61,500,000 1 mo. finished goods in inventory $100 x 8,000 tons x Rp.150/$l 120,000,000 1 mo. finished goods receivable $100 x 8,000 tons x Rp.150/$l 120,000,000

Rp.h30,500,000

15. The mission believes that the economic data available is inadequate to afford the Indonesian authorities a sound basis on which to make a decision either to continue construction at Tjilegon to completion, to abandon the project or to pursue some intermediate course. But a decision cannot be delayed beyond 8-12 months as much of the equipment will then be spoiled or corroded and a decision may then be unnecessary.

16. The situation is further complicated by factors surrounding two other "retarded projects", namely an iron/steel project in Southeast Kalimantan and pig iron project at Pandjang, Lampung in Sumatra. Ingots and/or billets for Tjilegon and for other users were to be produced in Kalimantan from Kalimantan iron ore. Pig iron was to be produced at Lampung for Tjilegon. All these projects should be reviewed simultaneously.

17. To advance the basis for decision, the mission makes the following observations and suggestions:

1. Capacity: Because of the size of certain rolling mill units, the staff considers it possible that the plant, with minor modifications, might have a demonstrable capacity considerably in excess of 100,000 tons annually. This possibility has been shared by several teams of experts who have spent some time studying the mill potentials.

This aspect is of great importance if substantiated. Let us optimistically assume a potential output of 300,000 annual tons (some have estimated 400,000). The cost per installed ton drops rapidly, depreciation is cut to one-third, production costs are reduced, profits increased, etc. But raw materials space needs are vastly increased, power consumption expanded, rail and ship movement increased, etc. Is there space? Is higher capacity attainable?

Fortunately, there is a simple inexpensive way to explore this matter. The Ceylon Steel Corporation in the vicinity of Colombo, have just started up a mill made in Russia having a design capa- city of 80,000 annual tons of the identical products, rounds, bars and wire. - 83 -

It is suggested that the Ceylonese Government be requested to receive a visit of engineers from the Tjilegon project, at which time drawings and specifications of Tjilegon can be compared with drawings, actual installation and operation of the equipment at the ,Ceylon Steel Plant.

2.. Any steel plant,built in a developing country should permit ready expansion in its quantity .of initial products and the addition of other types of steel products. This is parti- .cularly true in this instance where the initial production is only 100,000 tons in a country of over 100,000,000 persons.

Since construction has stopped, the location should be re- assessed and plant layout restudied, particularly in view of the large amount of money required to complete plant and infra-structure.

Therefore, it is suggested that a study be made by a team of steel experts to resolve questions such as the following:

(a) What are the market requirements of Indonesia in quantity and types of steel over the next 10-15 years?

(b) What is the probable output of the rolling mill at Tjilegon as delivered?

(c) Can capacity be measurably increased by increasing the speed of the motors? By eliminating bottlenecks? By adding additional shifts to the rolling mill operation? And at what additional cost?

(d) Should the rolling mill be installed and operated from imported billets instead of producing steel from pig iron and scrap by the use of open hearth furnaces?

(e) If steel is to be produced from pig iron and scrap, should the open hearths as delivered be scrapped and a modern basic oxygen furnace installed? (f) If the open hearths are installed, is the open hearth shop properly placed to permit further expansion of the rolling mill?

(g) Is there a probability that the future size of Tjilegon will justify installation of iron-making equipment? Is space conveniently provided at plant site for the in- stallation of this equipment? Will required additional land at the harbor be obtainable for such a large increase in operations? - 84 -

(h) Under (g), will the iron ore be imported or come initially from the small proven reserve of 5 million tons of high grade ore on Kalimantan? Since there are no indication of additional ore at this site, is it profitable to exploit that reserve based on infra-structure costs at the mine and at the Kalimantan Fort?

(i) What percentage of Indonesian coal can be used in the manufacture of coke if a blast furnace is installed later? Or, could suitable coke be produced from rubber-wood charcoal and profitably used as in Malaysia?

(j) Can the harbor handle Sumatra coal for the power plant and the coking operations? If not, could the village be moved and the wharf and storage areas expanded?

(k) Would it be cheaper to move the entire steel plant to Kalimantan or some other suitable location and use the Tjilegon power plant, and pipeline for area development; and the existing buildings for other industrial opera- tions?

(1) Or would it be cheaper to leave the steel mill at Tjilegon and produce coke, pig iron and steel billets by basic oxygen furnace and continuous casting at Kalimantan?

(m) Are there any advantages in having the pig iron operation at Lampung? If not, where should it be located?

18. Such a study costing, say, ;100-$150,000 and producing answers to these fundamental questions will be extremely valuable and will provide a basis for a decision whether to protect an existing investment of $38 million by the addition of $27 million, including working capital, or it will justify the continued suspension of construction and the possible loss through corrosion of $38 million of equipment.

19. Because time is of the essence under present conditions, it might prove of some help if the mission speculated on the probable recommendations coming out of the above study. The study could conceivably present a course of action along somewhat the following lines:

1. Finish the construction of the steel plant at Tjilegon, ex- cluding the open hearth shop.

2. Make a five to ten-year contract for steel billets with an overseas supplier to assure raw material supply for the mill and bring the cargo through the Port of Tangjung Priock (Djakarta) until Merak can be utilized.

3. Complete the power plant at Tjilegon. - 85 -

h. Use surplus power and water to create an adjoining industrial park.

5. Complete the water pipeline.

6. Temporarily suspend harbor development at Merak until its in- bound and outbound tonnage and storage facilities have been determined. Harbor facilities and harbor development plans should be redesigned to handle forecast tonnage and designed to reduce handling costs and interport and inter-island freight charges.

7. Discontinue further consideration of the Kalimantan and Lampung projects. If steel is produced in Indonesia later from ore, the import of ore from Australia, India or elsewhere could doubtless prove cheaper and eliminate large development expense for small reserves.

2. P.N. BARATA, SURABAJA

The Plant

20. This is the largest machine shop in Indonesia. Its major activities are:

(1) The manufacture of spares for sugar factories and other industrial enterprises. (2) The maintenance and overhaul of equipment for sugar, rubber and copra estates. (3) Steel fabrication, e.g. oil storage tanks, etc. (4) Centrifugal pumps for tin mines. (5) Bolts, rivets, etc. (6) Erection and installation of heavy equipment. (7) Assembly of road rollers. Operations

(1) During the past year, business has been very slow. Customers, although badly in need of Barata's goods and services, have not had the funds to pay for them. This condition is quite general and results from monetary and fiscal controls.

At present, there is only a single-shift operation, and even that operates at half strength. Because the power company cannot provide the necessary power during the peak hours of 5-11 p.m., a second shift would in any case be possible only from midnight to 7 a.m. - 86 -

(2) Large orders from Letjes Paper Co., North Sulawesi Power Co., and Djakarta Electric Power have been completed and are ready for shipment, but these companies have no funds. The price of these undelivered articles is adjusted upwards to compensate Barata for any loss through inflation. Total receivables and the outstanding accounts of these companies are already so high that the goods cannot be shipped without prior payment.

Finished goods inventory at Barata totals approximately Rp. 80 million. Current revenues are runing at the rate of Rp. 70 million, which is just about the break-even point. In an effort to maintain a reasonable level of operations, Barata has been producing standard items for stock but sale of these items has also been slow.

(3) This year's need for imported materials was U.S.$ 100,000, which was purchased through the existing "B.E." procedures. As will be readily surmised, the Company is beginning to face working capital problems, which will continue or worsen until their customers obtain credit facilities. Meanwhile, operations will continue at a low level.

Road Rollers

21. A series of 200 road rollers imported completely knocked down from Yugoslavia has been assembled and sold. According to estimates of the Department of Public ,orks, Indonesia needs 3,000 road rollers. Existing road rollers will need rehabilitation or replacement and it is presently planned to replace all existing units over a period of 15 years.

22. There are reasonable grounds to question the soundness of these estimates. One notices numerous new and old road rollers standing idle along the roadsides. It is observed that current road repair practice entails providing each small group of workmen (say, 20-30) with a road roller, but these men are breaking and laying the stone by hand and need a road roller about one hour per day. On a 40 KM stretch from Bandung to Tjilatjap there were 15 working groups, each equipped with a Barata road roller. Could present road repair procedures be modified? In any case, it would appear wise to base the estimated need on the funds scheduled for road rebuilding in the near future.

23. The selected model of road rollers originates in Yugoslavia and weighs six tons empty, eight tons filled with water. The selling price is Rp. 797,000. Cost comparisons and foreign exchange savings on which this project is based are as follows:

(1) A completed, assembled, Yugoslavian road roller costs c.i.f. $6,500. - 87 -

U.S.$ (2) Locally assembled in 1968 with All-parts from Yugoslavia, completely knocked down costs c.i.f. $6,000

Assembly costs Rp. 50,000 333 Total cost 6,333

Reduction in cost by local assembly is: 177

Foreign exchange savings 500 (3) Locally assembled in 1970 with 23 percent of Indonesian content:

Required parts knocked down, c.i.f. 4,500

Assembly and local parts Rp.200,000 1,300 Total cost 5,800

Reduction in cost 700

Estimated foreign exchange savings 1,500 24. The foreign exchange saving in merely assembling road rollers appears marginal. However, quite obviously, it is considerably simpler to import road rollers for assembly through one channel rather than permit each location to import direct. Certainly, there will be a saving through spare parts' standardization because, if permitted to import direct, each location would doubtless purchase from a different manufacturer. Furthermore, consolidation facilitates the arrangement of long-term credit.

25. However, if under case (2) above, 19 more road rollers are imported than necessary, the result can be a foreign exchange dissaving. The likeli- hood of a foreign exchange dissaving becomes less, of course, if, under case (3), the forecast of an indigenous content of 23 percent is achieved. However, experience in other developing countries points up the difficulties in achiev- ing such a target by 1970. Furthermore, the cost of producing special parts for a limited run of 200 units per year can prove more costly than presently estimated.

26. While the detailed terms of the contract with Yugoslavia are not known, the mission hopes that Indonesia is not required to accept delivery at the rate of 200 units annually if the need fails to develop. It also hopes that Barata's involvement will result in a wise and expeditious effort to increase the indigenous content rapidly and economically rather than in press- ing more units into service than the road-building program can fully justify. - 88 -

27. Recommendation. Since a suitable manufacturing area has been set aside in the Barata shops for the road roller operation, and since the equip- ment for assembly and partial manufacture is presently awaited, and since the needed rupiah costs for installation are minimal and can be provided by Barata, the mission recommends that the project proceed as planned with one proviso. It is urged that agreement be reached with the supplier that the acceptance of the equipment for performing the assembly as part of the credit does not obligate Indonesia to accept delivery of road rollers at the indicated rate of 200 units annually, if Indonesia's needs, in Indonesia's sole judgment, are less.

3. ASSEMBLY OF SA4OFA DIESELS - P.N. BISMA, SURABAJA, ASSEMLY OF KROMHOUT DIESEL- P.N. INDRA, SURABAJA

28. Both of these projects are financed through a credit arranged by Van Swaay International of The Netherlands in the amount HF 3,565, 748 covering 105 Samofa and 100 Kromhout units, which have all been delivered. When the mission visited the Bisma Plant, it found that all of the 105 units had been assembled and were ready for shipment. The same is doubt- less the case at Indra. While the projects are reportedly retarded by lack of rupiah financing, this lack of rupiah financing does not apply to Bisma or Indra, but rather to their prospective customers who were expected to purchase these units for the generation of power on estates. Of course, this depressing economic condition has the effect of freezing working capi- tal at the Indra and Bisma corporate levels and a turnover can hardly be expected until the general economic situation in Indonesia improves and these diesel sets move to ultimate consumers.

4. PETROCHEMICAL AND FERTILIZER PROJECTS

A. Petrochemical Project at Gresik

29. An Italian credit in the amount of U.S.$ '6.1 million has been arranged with Considit S.P.A. against which $40 million worth of equipment has already been shipped to the site. The financing for the rest may be disbursed in 1968. It was originally estimated that Rp. 500 million would be required for installation expenditures out of which about $32 million has been expended in 1966-67. The mission noted the large quantity of equipment at the plant site and. observed the site preparation and construc- tion work already completed which is estimated at 11 percent of the total. This plant, to be finished quickly and economically, will require a consider- able amount of planning on the part of the Government both to provide the large amount of rupiahs necessary and the vitally needed construction planning and expediting. The Director General of Chemical Industries has carried on some renegotiations with Considit S.P.A. in the expectation that modifications can be made in the scope of the project which will permit the work on the basic plant to go forward. - 89 -

30. This plant, which will produce fertilizer, has a high priority in view of the important position given to agricultural supporting activities in the Government's overall development program. The plant is scheduled to produce 150,000 metric tons of ammonium sulphate, 45,000 tons urea, 7,000 tons of amonia, 12,000 of sulphuric acid, 150,000 cubic meters of oxygen and 14,400 cubic meters of argon.

31. The product mix was determined sometime ago in consultation with the Department of Agriculture. It is an unusual product mix in view of present day trends.. The urea plant is particularly small by present day standards and will doubtless be a high-cost producer. It is also question- able whether ammonium sulphate would presently be considered as attractive compared with other products of higher nitrogen concentration.

32. It would seem wise to restudy this entire question of product mix to determine whether the sulphuric acid now scheduled to be used to produce the ammonium sulphate might not be more efficiently utilized to produce phosphoric acid from imported phosphate rock and converted to ammonium phosphate for the ultimate manufacture of high concentrate mixed fertilizer.

:33. In view of the fortunate surplus of ammonium at this plant, it is also suggested that provision be made for the necessary equipment to produce ammonium chloride using the surplus chlorine that will be generated at P.N. Soda at Waru when that plant.reaches its designed capacity. Ammonium chloride is widely used elsewhere as a successful agricultural fertilizer and is expected to be acceptable in Indonesia particularly since the quantity will be relatively small.

34. From an overall viewpoint, it is quite evident that the Government would prefer, if it were possible, to recast the product-mix in the light of current needs and to size the units above minimum economic production levels. They are, however, confronted with the necessity of making the best of the present situation. To that end the suggestions above with respect to the possible production of mixed fertilizer might afford an improvement in the economic performance of the project.

13. Tjilatjap Single Super-Phosphate Plant, Central Java

35. The equipment for this plant, most of which is at the site, was supplied under a credit of $8,450,735 granted by Russia. The machine shop is completed and the power plant well advanced. The sulfuric acid plant is about 40 percent completed. Because of shortage of rupiahs, all. work is stopped except for a limited amount of welding and an installation at the power plant to permit testing certain pieces of equipment under hydraulic pressure so that they may be filled, closed and protected. In certain res- pects, the plant appears over-built for Indonesian climatic conditions.

36. While construction is suspended, there are several basic problems that should be resolved before construction is resumed. To this end it is suggested that a qualified company be engaged to make a comprehensive and - 90 -

simultaneous review of this project and of the sulfur project at Warnaradja. Some aspects to be resolved are:

1) Whereas Indonesia has regularly preferred triple super- phosphate, Russia offered only a credit for single super- phosphate production since only single was produced in Russia and no process was available there for triple. Based on reports it is questionable whether single will be accepted by farmers and agriculturalists. It is understood that a quantity of single super-phosphate was imported in 1963 and has not been sold due to buyer resistance. What are the facts and forecast?

2) An investigation should be made to determine what the cost would be to install the additional equipment at Tjilatjap required to produce triple super-phosphate.

3) An investigation should be made to determine whether the existing sulfuric acid unit at Tjilatjap and in particular the sulfur burning section can be modified to burn the sulfur- containing mud from arnaradja (see "C" below).

4) A comparison should be made of the cost of adapting the sulfur burning unit at Tjilatjap to Warnaradja mud with the cost of building a flotation unit at Warnaradja. Attention should be paid to the comparative freight cost Warnaradja to Tjilatjap for pure sulfur and for mud.

5) Since mixed fertilizers will be in demand and since Tjilatjap is a port, consideration should be given to the possibility of adding a mixing unit to the plant if construction proceeds. Using urea from Pusri or ammonium sulfate from Gresik and potassium by import, Tjilatjap thus could conveniently supply the fertilizer needs of a large part of Central and West Java.

37. After the above data has been accumulated, a new estimate of rupiah required for completion can be prepared, and a decision made concerning the future of the plant.

38. Presently it is planned to rent or use the machine shop as a job repair shop to bring in some income. This action is unwise because the machines could be abused requiring replacement when the basic plant comes into operation.

39. If the study should recommend abandonment of the project, the power plant would be useful in supplying local power requirements and the site might be developed as an industrial park. - 91 -

C. Sulfur Project - Gurat and Warnaradja

LO. This project was formerly under the supervision of the Director General for Chemical Industries, but was recently relinquished to the Governor of West Java Province at the latter's request.

41. The existence of this sulfur reserve in the crater of a volcano has been known since 1830. In the 1900's the Dutch extracted a small amount of sulfur. During the Japanese occupation a road was installed up the mountainside for 13.5 Km from Warnaradja to the crater. At the end of World War II a pipe line was being installed to carry the sulfur mud 11 Km down the mountain to the plant site at Warnaradja 1 Km below. Both operations were destroyed.

42. After the War, a small plant consisting of 8 small autoclaves was erected, sulfur mud in small quantities is brought down the mountainside by truck and is being processed at the rate of approximately 3 tons per day, most of which is exported.

43. In 1962-1963 a Russian team made a geological survey of the volcanic sulfur reserves and after an extensive series of borings and analyses estab- lished that this was a promising source of sulfur and that the reserves of sulfur which could be economically processed amounted to approximately 850,000 metric tons.

44. The deposit exists in a crater which is bubbling in some places with hot steam resulting in some sublimed sulfur in those spots. The crater is slightly elliptical and about 3/4 Km on the longest axis. A lake of 12 meters depth with water of milky appearance and a Ph of 1.5 covers the deposit which averages about 30 meters in depth. The deposit exists in the form of mud varying in sulfur content from 20 to 70 percent. The basic plan of proposed operation follows the system presently in use in Russia:

1) Pump the mud from several portions of the deposit simultaneously to classifiers on shore in proportions designed to maintain an average concentration of 35 percent sulfur in the feed stock.

2) Return the surplus water from the classifiers to the lake to maintain an approximately constant level.

3) Use fresh water to realurry the mud and pipe it down hill to the plant.

4) The pipe will be 14 cm inside diameter at a cost of Rp. 70 million based on 1966 estimates. Depending on the slope and conditions of the terrain, steel, polyvinyl pipe, and a wooden sluiceway would be used in various sections. The sluiceway would be used on the lower three to five kilometers and installed on the stone piers (still standing) erected under the Japanese war program. - 92 -

5) The slurry would be run into flotation cells with the sulfur raised in the float and the mud going to a tailings dump.

6) The sulfur would be washed and melted into blocks or pellets having a purity of plus 99 percent.

45. It has been suggested that instead of the foregoing process it might be possible to eliminate the flotation step and burn the mud directly (possibly at Tjilatjap) to produce sulfuric acid which appears technically possible, and may prove to be the most advantageous economically.

46 . The original program entailed the completion of this sulfur process- ing unit concurrently with the single phosphate plant at Tjilatjap on which construction is suspended. This Warnaradja sulfur was to be used at Tjilatjap to produce the sulfuric acid requisite to the planned single phosphate output. It is essential that the future of this sulfur deposit at Warnaradja and the destiny of the retarded single phosphate plant be considered together.

47. It is understood that River International Corporation has indicated through its Eastern Representative, Mr. Hehumat, a possible interest in investing in the sulfur project. Further indications of their continuing interest are awaited.

48. Studies have indicated that a project to produce 70,000 tons of sulfur annually will cost US $3 - 4 million in foreign currency plus Rp. 225 million for local expenses excluding working capital. It is expected that 650 people would be employed.

49. It is reported that the estimated production cost will be sub- stantially below international sulfur prices.

5. ALUMINUM PROJECT AT MLBAR, EDAN

50. A preliminary process design was completed in 1965 and indications given by the U.S.S.R. that a credit would be available. While the exact amount of the credit was not established, the foreign exchange estimate amounted to $60 million of which $870,000 has been expended. Some temporary construction sheds have been completed at a total expenditure of Rp. 1,274,956. The original project study made jointly by Indonesian and Russian personnel is now being resurveyed by Nippon Koei. The project was based on the expectation that the Sigura-Gura hydroelectric plant would be constructed and that this project would be its main consumer of electricity.

51. Recently there have been negotiations in respect to a foreign investment proposal from the Aluminum Company of America and it is hoped that these discussions will prove fruitful. Quite obviously there will be little prospect of this project coming to maturity until a basis can be found for the concurrent financing of the hydroelectric power plant (Asahan). These projects will be the cornerstone of an area development plan. - 93 -

6. ELECTRIC BULB PROJECT - SEMARANG, CENTRAL JAVA

52. This plant was constructed with Hungarian credit in the amount of 770,680. 90 percent of the machinery has been delivered and some 45 percent installed. To date Rp. 24.6 million have been expended for construction and installation and a much larger amount will be needed if the plant is to be completed. Unfortunately, the scope of the project as planned is too large, the plant buildings too elaborate and the quality of the product unsatis- factory. Therefore, the plant management and the Ministry personnel have now concluded that (a) this project is ill-conceived, (b) no further efforts should be made to complete it, and (c) some alternate program should be undertaken whereby a project is established to produce quality florescent tubes in a quantity commensurate with Indonesia's needs.

7. WELDING ROD - P. N. SABANG MERAUKE - DJAKARTA

53. This company which operates a machine shop and a structural steel fabricating unit has undertaken a project for the manufacture of 1,240 tons per year of welding rods. A credit from Hungary in the amount of 158,450 has been obtained and it is expected that the project will have a value of Rp. 3,372 million when completed. Apparently nothing has been expended in 1966 or 1967. The building is 100 percent complete.

5h. It is recommended that the entire subject of welding rod require- ments for Indonesia be restudied to determine the proper and most economic size for such a project, the various qualities of rod required to meet present and future needs, and the most efficient type of equipment with which to produce this widely used item.

8. SHIPYARD, MAKASSAR - SOUTH SULAWESI

55. The proposed.shipyard is to be built with credits from Poland. Initially it will build and repair 300 dWt. wooden ships equipped with engines for coastal and inter-island shipping. Later steel ships are also to be built, and repaired in this yard. It is reported that the Polish credit covers only the first phase consisting of wooden ships.

56. Supposedly this would be the only shipyard in East Indonesia. 65 - 70 percent of the equipment has been delivered and a part of the civil works (foundations) have been completed. An additional Rp. 50 million are required to get into production. The shipyard will have two diesel generators.

57. Despite the Governor of South Sulawesi's keen interest to see this project go forward, the mission is regretfully compelled to urge that the project be abandoned and the equipment used for other purposes. - 94 -

58. In the opinion of the mission the project will not be able to compete with nearby native shipbuilders who, without elaborate equipment have been producing sailing ships of 200 - 300 dwt. for many years selling for Rp. 500,000 ($3,300). Now these shipbuilders with the help of the Regional Development Bank plan to purchase engines to install in improved and strength- ened hulls, thus producing approximately the same item as the Polish shipyard, but for a much lower price.

59. In addition to the matter of price, there is the question of skills, talents, know-how and craftsmanship. Obviously experienced labor is not available to the new shipyard because a wooden ship was being built for purposes of training the workmen. It was a poor specimen. It was fair to assume that quite some time would elapse before seaworthy crafts are produced.

60. On the basis both of cost and craftsmanship it appears wise to leave this work to the native shipbuilders.

61. The equipment of the shipyard can be distributed among various industries and the generators can be used in factories needing more power. The local rupiah expenditure has not been large and therefore the net loss would not be substantial.

9. ELECTRIC MOTORS AND GENERATORS - P. N. 1ETRIKA, DJAKARTA

62. This project for the production of 8,000 electric motors and 2,000 generator sets was arranged with a credit from Bulgaria in the amount of L990,000 against which L 110,000 have been expended. The amount of rupiahs spent is not available. The project is held up for the customary reason of rupiah shortage. It is understood that Van Swaay International of the Netherlands played a part in arranging the original credit or is planning to take a joint interest in this project.

63. Because of the wide use of electric motors and generators, it is recommended that the entire question of Indonesia's present and future needs in this field be evaluated before the project is resumed. It may prove possible to solicit the investment by, or the supply of know-how from, a large foreign manufacturer in this field. It may also prove necessary and advisable to change the scope and even the location of the project. - 95 -

10. PAPER PROJECTS

A. Martapura, South Kalimantan

64. Construction at this plant is suspended for lack of rupiahs. The plant has a design capacity of 4,000 tons of writing paper and is being financed by a $4 million credit under Japanese reparations. Approximately Rp. 7.2 million have been spent on the project to date. While the amount of equipment shipped to the project has .not been provided to the mission, it is understood that a considerable portion of the equipment, perhaps as much as 70 percent, has been off-loaded by barge on the shores of South Kalimantan. While Rp. 7.2 million have been spent, little progress has been made in connection with the infra-structure required. A feasibility study,was made by Nomura Trading Company of Japan. Even if the project were permitted to proceed an additional credit would be required to provide the necessary logging and transportation equipment to bring the logs to the plant site.

65. This is an example of the small paper plants which have been supplied by Japan under reparations. In each case the Indonesian Government attempted to satisfy provincial longings by establishing a plant in each of the provinces - a political rather than an economic decision. The end result in all of these cases is the erection of a plant far below minimum economic size producing a high cost product which finds great difficulty in competing with imports.

66. It is recommended that this project be re-evaluated to determine the proper economic level giving due weight to the carrying charges for the large expenditures that will be required .for an adequate infrastructure. If the project cannot be expanded to that level then consideration should be given to moving the equipment to the location of one of the existing paper plants. Such a step might raise the production and earnings substantially on an incremental basis at the new location since it would take advantage of existing infrastructure expenditures.

B. Takengon, Atjeh, North Sumatra

67. This plant scheduled to produce 30,000 annual tons of printing and writing paper under a credit of $27 million from Japan through Toyo Menka Kaisha Ltd. is also suspended for lack of rupiah financing. Fortunately, the Indonesian Government is taking advantage of the delay to determine whether the site selected is suitable. In addition, efforts are being expended to renegotiate the supply contract to a more.advantageous basis. So far only some small units of road construction equipment have arrived and to date only approximately Rp. 3 million have been spent for local expenditures.

68. Again this project together with all of the other paper projects under construction should be reviewed and evaluated to provide the require- ments of paper for Indonesia on a sound and economic basis. A proper review of this entire industrial sector might indicate the possibilities of consider- able exportation in view of the large natural resources of Indonesia. - 96 -

C. Notog, Central Java

69. It was planned that this project would produce 15,000 tons of Kraft paper to be used for wrapping paper and corrugated board production at an estimated foreign exchange cost of $18.5 million plus Rp. 1,250,000,000. It was originally expected that the credit for this project would come from East Germany which had made the original project study. Only Rp. 548,000 have been spent on the project to date in connection with the acquisition and clearance of the plant site. It is understood that some initial discussions have taken place with Boise Cascade Company in respect to their possible investment in this project and its development. While it is hoped that this interest develops favorably, the production at this location should neverthe- less be studied promptly in connection with the overall paper requirements of the country.

11. PLYWOOD PROJECT AT PALOPO, CENTRAL SULAWESI

70. This project has a designed capacity of 600,000 sheets of plywood and is being constructed under a Japanese reparations credit of $3,204,353. About 65 percent of the equipment has been shipped in the amount of approx- imately $2 million. In 1966 Rp. 10.8 million were spent before a shortage of rupiah caused suspension of construction.

71. The Government has re-evaluated and approved the feasibility of this project but points out that an additional $2.5 million will be required for additional machinery and all necessary logging equipment before the project can become an operating unit. Meanwhile, the project has been trans- ferred to the armed forces who will now have the responsibility for carrying it to completion.

72. It is urged that the establishment of plants for the processing of lumber to different end products should be carefully studied so that different operations may be integrated at a given site to utilize the lumber in the logs most advantageously. It is also expected that a careful study along these lines will indicate the types of product to which the particular woods available should be directed to obtain the maximum foreign exchange value.

12. CITRONELLA PROJECT AT TAWANGMANGU, CENTRAL JAVA

73. This suspended project was designed to produce 150,000 kilograms annually of citronella oil on a production sharing basis between the Indonesian State Corporation P. N. Kimia Yasa, and Bulgaria which provided a credit of $545,400, all of which has been expended. In addition, Rp. 6.5 million have been spent locally. Plant has been constructed to minimum requirements for initial operation. - 97 -

74. Unfortunately, the price of citronella has dropped on the inter- national market and re-evaluation indicates that the cost:of production will be considerably above the world selling price. Consideration has been given to using the plant for the production.of other oils but this shows little promise and the operations will continue to be suspended until some other use for the project can be found.

13. OTHER PROPOSED OR SUSPENDED PROJECTS

Soda Ash Project - Madura

75. Approximately Rp. 294,000 have been spent in exploring the possi- bility of establishing a soda ash project on the the Island of Madura but no credits have been arranged and no definitive plans laid. The Government is hopeful that this project will prove attractive to some foreign investors who will undertake the construction of a plant large enough to supply the growing requirements of Indonesia.

Window Glass Project, Djakarta, Java

76. This project has a design capacity of 15,000 tons or 2 million square meters of glass at 3 millimeters thickness. It was estimated in early 1965 that foreign exchange needed would be US $3.5 million with local funds necessary on that date estimated at Rp. 15 million. To date some Rp. 250,000 have been spent, 10 hectares of property have been acquired for a plant site and some site preparation has been completed. No credit has been arranged. Currently there are conversations with certain Belgian and French companies who indicate a possible interest in investing in and carrying the project to completion. Again it is hoped that the discussions will prove fruitful.

Vegetable Oil Plant - Production Sharing Projects 77. The previous government had evolved a plan under which investments from Eastern European countries would be made in the private sector with private entrepreneurs on the basis that the lending country would receive a share of the product as repayment for the .credit. The present government considers these contracts unsatisfactory and have cancelled 20 such projects which were in the early stage of negotiation with East Germany, Czechoslovakia and Yugoslavia.

78. However, several projects' of this nature were in an advanced stage of negotiation or commitment and are listed below. All of them are suspended because of the shortage of rupiah. During this suspension period the Govern- ment is hopeful that foreign investors will consider these projects attractive and provide the necessary funds to complete them with normal financing arrange- ments so that the production sharing aspect can be eliminated. - 98 -

79. While it is recognized that there is a large domestic need for cooking oils of various types and a substantial international market for these products, it is recalled that an earlier Bank mission found Indonesian companies having difficulty selling cooking oils because small operators produced more cheaply. The question naturally arises whether these several projects do not justify now a thorough review to determine whether the basis on which each of them is predicated will currently produce viable operations. This concerns not only the oil produced from the extraction plant but also the cattle fodder which some produce as a by-product.

80. It would be well also to determine the proper value for the equip- ment supplied in order to establish a sound depreciation pattern and to ascertain whether the equipment was competitively priced in view of the profit sharing aspect imposed on the creditor. The projects involved are:

P. T. Gatotkatja, Sun Flower Seed Extraction Plant, Djakarta

Design capacity is 30 tons per hour. Equipment cost US $2.8 million from East Germany plus Rp. 30 million required locally.

P. T. Bison, Rice Bran Oil Extraction Plant, Djember East Java

40 tons per day of rice bran under a credit of US $1.5 million from East Germany plus Rp. 30 million for installation.

P. T. Bison Cooking Oil Expeller at Bitung, North Sulawesi

35 tons of copra under a US $2.9 million credit from East Germany and Rp. 30 million.

P. R. Ribrano, Rice Bran Extraction Plant at Karawang, West Java

1,680 tons annually of oil, 9,900 cattle fodder, under East German credit of US $1,9 million plus Rp. 35 million supplied locally.

P. T. Pita Kumala, Essential Oil Distrillation Plant, Blang Rakal at Atjeh, North Sumatra

50 tons of citronella and 6 tons of patchorelli leaves per day under a Bulgarian credit of US $775,000 with the rupiah not estimated.

P. T. Sri Bunian Cooking Oil Expeller

Under a Bulgarian credit of US $1.6 million with rupiahs not estimated. APPENDIX 3

DEVELOPMENT FINANCE COMPANIES

Background - Existing Development Banks

1. Indonesia has a national development bank, Bank Pembangunan Indo- nesia (Bapindo) involved primarily in the public sector, which is now pri- marily operating as .a commercial bank. It was formed in 1960 to take over the functions of the Industrial State Bank, which had promoted about 40 of Indonesia's larger industrial companies, including the 400,000 ton per year cement plant at Gresik, the 100,000 ton per year urea plant at Palembang, the glass factory at Surabaja, etc. In 1961 these companies were taken over by the various ministries although their shares remained with Bapindo. More or less concurrently Bapindo was given the function of disbursing budget funds for new state enterprises which were being formed, which included among others the steel mill at Tjilegon, the fertilizer complex at Gresik, the single superphosphate plant, several paper plants, etc. Many of these projects faced difficulties including the single biggest problem which was the lack of local currency financing to complete the projects. In 1966 this function of disbursing funds was taken over by the Ministry of Finance and Bapindo was given authority to accept deposits from the public and make short-term loans to industry. Bapindo employs 1,300 persons, including staff at its 20 branch offices.

2. The national private development bank, Bank Pembangunan Swasta, was organized in 1963 with very little capital, which with inflation now amounts to only U.S.$0,000 equivalent. This bank employs seven persons, and its operations consist of keeping its funds on deposit with private commercial banks at an interest rate of 5 percent per month, which pays for the salaries of the staff. The concept of this institution was that each private company would be assessed a certain amount each year, for which, if the companies were owned by citizens, shares would be given and, if owned by foreigners, non-interest bearing certificates of deposit would be given. Virtually no funds were collected through such assessments, the criteria for which was never quite clear.

3. There are 21 regional development banks, one in each provincial capital except for South East and Central Sulawesi. These banks were owned jointly by the states and private parties, and the Government gave them interest-free loans equal to the share capital. Most of these banks now have the authority to accept deposits and carry on normal commercial banking functions. These banks have met with varying success. In Makassar, South Sulawesi, the regional development bank is flourishing and seems to be making a useful contribution. In Djakarta by order of the Governor the private shareholders of the regional bank were repaid the par value of the shares with rupiahs which were virtually valueless through inflation. The bank is functioning as a commercial bank but cannot compete with the private commercial banks. The regional bank at Bandung is run by private parties and is said. to be successful. Aside from the banks at Makassar and Bandung, however, the regional banks are said to be unsuccessful. - 100 -

4. The development banks in Indonesia are controlled by Bank Negara Indonesia (BNI) and must follow its policies on interest for loans to certain priority sectors, such as agriculture, priority manufacturing industries, etc. The rates vary from 3 percent to 5 percent per month. To che remainder, the banks charge up to 10 to 12 percent per month. The bulK of the lending of the successful regional development banks is at 10 - 12 percent per month, repayable within 8 - 10 months. The maximum repayment period for the bank at Makassar is two years.

5. Under the highly inflationary situation iA Indonesia and the indus- trial policies adopted by the Government, it is understandable that the long- term credit institutions fared badly. Those which survived, which essentially are the two or three regional development banks, did so because they had sufficient freedom from state control to lend only on a short-term basis and to charge interest rates more in line with the unorganized money market rather th6rat the rates set by the Bank Negara Indonesia.

Credit Availability

6. Short-term Credit. Indonesia's medium and larger industries are state-owned and they obtain credit for working capital from the BNI. Interest rates vary from 3 - 5 percent per month depending on the priority given to the industry and are repayable between 3 months to 12 months. The acute shortage of credit has caused tome of the state enterprises to borrow from private commercial banks at rates of 10 - 12 percent per month. Before prices and the exchange rate were freed in 1966 the state-owned enterprises had to sell their goods at controlled prices, and although the raw materials purchased were on credit which was subsidized,they generally operated at substantial losses which were made up by advances from the Government. With the change in regulations freeing sales prices of both raw materials and finished goods and with the arrival of substantial amounts of commodity aid, the companies were expected to increase output quickly and compete with imports. The demand for credit was enormous and was to some extent met; nevertheless, the companies needed further credit if output was to be increased. The stabilization measures limited credit expansion.Thus the industrial sector still faces an acute credit shortage which cannot be alleviated within the limitations on credit necessary for checking inflation. Here the position rests.

7. There is no question that as long as the interest rate is maintained between 3 - 5 percent per month and the inflation rate continues at 10 percent per month the demand for credit will be exaggerated. However, a genuine short- age of credit for working capital to industry persists and if industrial out-- put is to be increased through higher capacity utilization,further credit to industry is necessary.

8. Private industry obtains credit for working capital either through private commercial banks, deposits from the public, or money lenders. The rates vary from 12 - 20 percent or more per month. Nevertheless, private business survives and although high interest rates are their chief complaint they seem to manage. In due course, as this sector expands there will be a problem which will have to be tackled. - 101 -

9. Long-term Credit. The state-owned enterprises obtain long-term financing through government advances denominated in rupiahs, even for those credits which the Government obtains from abroad and relends. These advances are interest free and have no repayment period. The Government intends in due course to convert them into equity and loans on terms to be determined. The criteria for doing this has not been established but it appears likely that they will be converted entirely into equity.

10. The method by which new projects will be floated or the terms on which further funds would be given to state industries have not yet been considered by the Government. Essentially the same is true for how to treat government advances to industry or for that matter who should hold the shares of existing or new companies.

11. It is important that state enterprises continue to have access to long-term financing. They are intended to be the major beneficiaries of the $17 million or so foreign industrial project aid being sought for 1968. The initial allocation of these funds amongst the industries was done on the recommendation of the Bank mission to a committee of Bappenas, It is not clear under what arrangements the rupiahs required to utilize these foreign funds will be allocated or by whom. Similar questions arise as to the allo- cation of future foreign project aid and the rupiahs necessary to use these funds.

12. Private industry has no access to long-term financing. It could conceivably get funds from tle Government but this appears unlikely. The development finance institutiois do not have funds to make long-term loans. Furthermore, they are not inclined to do so. Private industry cannot obtain suppliers' credits because they cannot provide acceptable Indonesian bank guarantees. In short they cannot buy equipment except out of earnings or personal wealth, and both are limited. Although the private sector is small it must not be neglected, There must be means for responsible and sound businessmen to obtain these guarantees, perhaps from the BNI's commercial banking unit. Furthermore, there must be a mechanism under which a portion of the foreign project aid to industry can be re-loaned to the private sector on appropriate terms.

Need for a Development Finance Institution

13, There is little doubt that Indonesia needs an effective development finance institution, Such an institution could make a significant contribu- tion. The present institutions do not appear to be suitable, even if re- organized, to carry out the functions intended for the new institution. Further studies would have to be made before this view could be substantiated.,

14. The demand for long-term industrial financing can be divided into three broad categories: - 102 -

a) Existing and New State-Owned Enterprises. The state-owned companies constitute Indonesia's medium and large enterprises. Currently these enterprises are directly controlled by the ministries. Indonesiaabusinessmen have relatively little capital for starting new industrial ventures. Therefore larger industry will be developed primarily by state enter- prises and it is these enterprises both new and existing which will be the major clients of any new institution.

It is difficult to predict this sector's annual demand for funds from a new development finance institution. It would not be unreasonable to assume that projects in which this institution would be interested could total $30 - $40 million per year. If 50 percent of this comprising the foreign exchange component, were financed by foreign project aid or suppliers'credits, the major part of the remainder of the financing of $15 - $20 million equivalent would have to be considered by the new institution. b) Joint Ventures - Foreign Companies and Indonesian Government. Since private foreign capital is being sought and Indonesian participation in the ownership is desirable, it seems likely that for larger projects in the manufacturing sector, this pattern will be quite common. It seems likely, and also advisable, that the new institution would be the Indonesian shareholder in suc:h joint ventures and in due course as the shares matured, it could begin marketing them with a view to developing a capital market. The need for funds to cover the Indonesianpart of the share capital in joint ventures would depend on the response Indonesia gets to its efforts to attract capital and the efforts of the Government to convince foreign companies to give up shares, particularly in the field of mining. c) Private Sector. It seems likely that this will require a relatively small amount of financing annually. There are relatively few Indonesian entrepreneurs other than the Chinese community, with sufficient capital to enter industry on a large scale. The "Domestic Investment Law" is attempting to give time to the Chinese businessmen to achieve an "acceptable" degree of "Indonesian" ownership, but even if this law is passed with such provisions, the Chinese entrepreneurs are not likely to receive substantial funds from the new institution. Nevertheless, the private textile industry, vegetable oil industry, and consumer goods industry will require, at a rough guess, $3 - $4 million per year. - 103 -

Certain Considerations in Establishing a New Development Finance Institution

15. There are several important considerations which must be borne in mind in establishing a new institution.

16. This institution will perform only one of many functions neces- sary to foster Indonesian industrial development. It is necessary that special bodies be organized to carry out the functions of industrial plan- ning, administering the foreign investment law and domestic investment law when enacted, advising on tariff protection, preparing projects, etc., concurrently with organizing a new development finance institution. This is most essential if the new institution is to avoid having some or all these functions imposed on it as is presently envisaged in certain Indonesian official circles. A piecemeal approach to evolving the govern- mental organization necessary to assist and administer to industrial de- velopment would not be wise. It must be approached as a package and advice sought accordingly.

17. Currently Indonesian officials appear to be thinking in terms of a single development finance institution. Separate institutions may be necessary for the public and private sectors. Small and cottage industry financing may need an altogether different approach. Perhaps existing regional development banks could be used for financing small industry and it may well be that with proper strengthening they could play an important role in providing long-term financing to private industry as a whole. The Government must strengthen and make more effective its procedures for pro- viding and controlling funds to projects. Government would continue to finance projects which fell outside the scope of the new institutions or which were disqualified on business considerations but were necessary on social and economic grounds.

18. The Government's policy on industry giving virtual autonomy to existing and new state-owned enterprises must show signs of being success- fully implemented. The Indonesian Government has taken the decision to make these Enterprises autonomous but these policies have not been imple- mented effectively. The difficulty is in bringing the state enterprises, both financially and managerially, to a point where they can successfully conduct their own affairs. There are only a very few successful state enterprises today. Most of them need funds, management, technical assist- ance, and to a greater or lesser degree protection from imports. The prospects for new enterprises are better because these projects will be developed more carefully. If the various ministries continue to create and run the affairs of state enterprises, business-oriented management is unlikely but because of the scarcity of funds the new institution would have to provide financing to them and this could seriously affect the institution's chances for success.