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Evolution, Drivers and Impact of Commodity Prices: Implications for Indonesia Table of Contents Acknowledgements ix Preface x Acronyms xiii Executive Summary 1 Summary of the Chapters 4 Chapter 1 Rising Food Prices: The Impact of Increased Production of Biofuels 17 1.1 Introduction 18 1.2 The rise in global food prices 19 1.3 Recent examinations of the contribution of increased biofuels production on increased food prices 20 1.4 Estimates of factors contributing to the rise in food commodities prices 22 1.5 Conclusion 32 Chapter 2 Pricking the Price Bubble to Avert a World Rice Crisis 35 2.1 Introduction 36 2.2 The nature of rice: Thin markets, quality segmentation, concentrated exports and politically sensitive 37 2.3 Factors that were not the key drivers of the 2008 price increases: Oil, biofuels, the US dollar, and shortfalls in production 39 2.4 Factors that were key drivers of the 2008 price increases: trade restrictions and buying behavior 42 2.5 Price scenarios: Stay high, escalate further or go down 44 2.6 Policy responses to prevent further escalation of the global rice crisis 46 2.7 Postscript: what happened next? 48 Chapter 3 Commodity Price Shocks and Market Integration in Indonesia 51 3.1 Introduction 52 3.2 Spatial integration of Indonesian commodity markets with the world 53 3.3 Integration among Indonesian provinces 58 3.4 Determinants of market integration 60 3.5 Commodity price volatility 66 3.6 Conclusions and policy implications 69 Chapter 4 Impact of Commodity Prices on Indonesia’s Economy 73 4.1 Introduction 74 4.2 The Wayang 2005 general equilibrium model 76 4.3 Results and discussion 80 4.4 Conclusion 88 Chapter 5 Managing Commodity Price Shocks in Indonesia 91 5.1 Introduction 92 5.2 Impact of high commodity prices and volatility: Exporters, consumers, producers and the Government 93 Boom, Bust and Up Again? ii Evolution, Drivers and Impact of Commodity Prices: Implications for Indonesia Table of Contents 5.3 Coping with commodity price shocks: The Indonesian experience 98 5.4 Recent international policy responses to commodity price increases and volatility 106 5.5 Policy recommendations for Indonesia 111 Chapter 6 Indonesia’s Growth and Exports Trends: Macro and Sectoral Perspective 117 6.1 Introduction 118 6.2 Indonesia’s growth: Long-term macro trends and engines of growth 118 6.3 Sub-national growth 123 6.4 Export performance and its drivers 126 6.5 Drivers of growth in Indonesia’s export performance since 1998 132 6.6 Implications for trade development strategy 140 6.7 Conclusion 141 Chapter 7 Making the Most of High Commodity Prices for Indonesia’s Development 143 7.1 Introduction 144 7.2 The importance of commodities in Indonesia’s economy 145 7.3 Commodity based development: Challenges and opportunities 147 7.4 Indonesia and increased commodity prices: Impacts and missed opportunities 150 7.5 The new global reality: High and volatile commodity prices 156 7.6 Indonesia: Having its cake and eating it too 158 7.7 Conclusion 176 Annexes 179 Annex I 179 Annex II 182 Annex III 205 Annex IV 226 Annex V 230 Annex VI 233 Annex VII 247 References 258 Boom, Bust and Up Again? Evolution, Drivers and Impact of Commodity Prices: Implications for Indonesia iii Table of Contents List of Figure Figure 1: Drivers of food price increases 5 Figure 1.1: International food prices 19 Figure 1.2: International food price sub-indices 20 Figure 1.3: Global maize use 25 Figure 1.4: Global vegetable oils use 25 Figure 1.5: EU oil seeds imports 26 Figure 1.6: US maize and soybean area 27 Figure 1.7: Wheat and oilseeds area 28 Figure 1.8: Wheat stocks, actual and simulated 28 Figure 1.9: Wheat prices vs. stocks 29 Figure 1.10: Impact of India’s ban on rice exports (Thai rice export prices, US$/ton) 29 Figure 1.11: Global grain consumption 30 Figure 1.12: Food prices vs. exchange rate 31 Figure 1.13: Wheat open interest and prices 32 Figure 2.1: Real rice prices, 1961-2008 37 Figure 2.2: Comparison of Thai and US rice export prices, 2005-08 38 Figure 2.3: World grain stock to use ratios 40 Figure 2.4: Commodity prices in current US$ (2003=100) 43 Figure 2.5: World market rice price, 2004-08 (Thai 100B export price) 45 Figure 2.6: Rice prices (Thai 100% B) and export restrictions 49 Figure 3.1: Evolution of world commodity prices 54 Figure 3.2: Adjustment to the shock in the world price of rice 58 Figure 3.3: Evolution of price dispersion 61 Figure 3.4: Contributions of remoteness and infrastructure to rice price diff erences 65 Figure 3.5: Rice price volatility: Indonesia and abroad 68 Figure 5.1: Exports increased with commodity boom 93 Figure 5.2: Indonesia almost doubled its foreign reserve assets 94 Figure 5.3: Infl ation rates, 2007-08 95 Figure 5.4: Eff ect of a 10 percent increase in rice price by income deciles 95 Figure 5.6: Indonesian Government bond yields appear to track the cost of subsidies 97 Figure 5.7: The impact of severe shocks on economic progress 97 Figure 5.8: Food outpaces general infl ation 98 Figure 5.9: Rising international prices of food 99 Figure 5.10: Except for rice, prices in Indonesia were aff ected by increases in international prices 99 Figure 5.11: Domestic price of cooking oil was stabilized following increase in export tax of CPO 102 Figure 5.12: Trade restrictions triggered panic in global rice market 103 Figure 5.13: Fuel subsidies benefi t the rich more than the poor 104 Figure 5.14: Energy subsidies are becoming unsustainable 104 Figure 5.15: The fuel price is set below its economic cost 105 Figure 5.16: Fuel prices in Indonesia are among the lowest in the region 105 Figure 5.17: Country experiences and concerns of social unrest 107 Boom, Bust and Up Again? iv Evolution, Drivers and Impact of Commodity Prices: Implications for Indonesia Table of Contents Figure 6.1: Indonesia’s GDP per capita 119 Figure 6.2: Indonesia’s annual GDP per capita growth 119 Figure 6.3: Indonesia’s growth in the past quarter century has come primarily from manufacturing and services 119 Figure 6.4: Contribution to GDP growth by sector-- weighted by sector’s share in value-added 121 Figure 6.5: Contribution to labor income growth by sector (weighted by sector’s labor intensity) 121 Figure 6.6: Labor intensity by sector 121 Figure 6.7: GDP per capita growth and labor intensity premium 122 Figure 6.8: Regional growth per capita and labor intensity premium, 2001-05 -- simple rates 124 Figure 6.9: Regional growth per capita and labor intensity premium, 2001-05-- population 2001-adjusted rate 124 Figure 6.10 : Sumatra growth per capita 2001-05 -- population 2001 adjusted rates 125 Figure 6.11: Java Bali growth per capita 2001-05 -- population 2001 adjusted rates 125 Figure 6.12: Kalimantan growth per capita 2001-05 --population 2001 adjusted rates 125 Figure 6.13: Sulawesi growth per capita 2001-05--population 2001-adjusted 125 Figure 6.14: Eastern growth per capita 2001-05---- population 2001-adjusted rates 125 Figure 6.15: Growth and output’s initial levels per region, 2001-05 126 Figure 6.16: Export growth by sector 127 Figure 6.17: Exports composition – long term changes 127 Figure 6.18: Manufacturing export growth 128 Figure 6.19: Manufacturing export intensity growth 128 Figure 6.20: Number of exported products – Only trade fl ows larger than US$100,000 129 Figure 6.21: Old stuff still dominates export growth 130 Figure 6.22: Relationship between export and subsequent growth 131 Figure 6.23: EXPY or income earning of export baskets 131 Figure 6.24: Comparing the evolution of exports sophistication – Indonesia vs.