Preparing for the harvest: The government is creating growth zones and enhancing regulations

Following the well-established path towards rapid economic development, Indonesia has long relied on selling its vast reserves of natural resources. At the same time, more markets have been eager to snap up raw materials such as crude palm oil (CPO), cocoa, rubber and other products to fuel their manufacturing. This trajectory has shown signs of altering in 2011 as the government has become more proactive in terms of expanding downstream industry, particularly through revising export tariffs and other related measures. At the same time, Indonesia is instituting several wide-ranging development programmes to dramatically boost its agricultural output. Finally, the government is becoming increasingly mindful of the social and economic implications of environmental sustainability and is thus enacting more environmental regulations.

SELF-SUFFICIENCY: Despite a thriving agricultural industry, Indonesia is still not able to provide enough food to feed its 240m inhabitants. As a result, the country imported 11m tonnes of food at a cost of $5.36bn through the first six months of 2011 according to the Central Statistics Agency (BPS). In order to remedy this, the government has instituted several food development programmes in recent years and is designating some areas as agricultural development corridors within a larger plan for 2025. First initiated in 2007 as the Merauke Integrated Rice Estate as a means to secure domestic food supplies by transforming Merauke into the nation’s rice centre, the estate programme has since evolved into the much larger Merauke Integrated Food and Energy Estate (MIFEE). Situated in Papua on a total allocated area of 1.2m ha, the MIFEE consist of 10 clusters which are designated for the development of food crops (70% of land allocation), livestock (9%), fisheries (8%), plantations (8%) and support facilities (5%). Total investment for the programme is estimated at $1.3bn and foreign ownership of up to 49% of local plantations is allowed within the estate. When in full production, the programme’s projected output includes 2m tonnes each of rice and corn, 167,000 tonnes of soybeans and 2.5m tonnes of sugar.

Priority areas for development for 2011-14 are clusters I and IV encompassing a total area of 464,954 ha, 228,022 designated as clear and clean zones to facilitate planting of rice, corn, soybean and sugar cane as well as cattle grazing lands according to the Indonesian Ministry of Agriculture (MoA). As of February 2011, the Merauke Regency Regional Investment Coordinating Board (BKPMD) recorded that 46 companies had obtained licences necessary to develop agricultural businesses such as oil palm, sugarcane, corn, and other staple foods and fisheries within the MIFEE project. Complementing the food estate programmes, the MoA has been mandated to established six economic corridors for agricultural development under the government’s Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development through 2025 (MP3EI), with total investment of Rp3.35tn ($402m).

DEVELOPMENT: The form of agricultural development is based on the commodities suited to each region. The Sumatra Economy Corridor is designated as a centre for palm oil and rubber; Java for food industry development; Kalimantan for palm oil, rubber, corn, soybean, cassava and livestock; Sulawesi for rice, corn and cocoa; Bali for corn, livestock and soybean; and Papua for food crops, estate crops and livestock. Under the MP3EI, downstream industrial clusters are also planned for South Sumatra and Riau, along with oleochem processing facilities in Sei Mangke, North Sumatra, Kuala Enok, Dumai, Riau, Maloy and East Kalimantan.

The government has also developed a series of financial incentives to spur agricultural development within the economic corridors. The most significant of these include Presidential Regulation No. 36/2010 (“Negative Investment List”), which allows up to 95% foreign ownership in palm oil plantations once a recommendation from the MoA and Directorate of Plantations is issued; MoA Regulation No. 12/2007, allowing the government to provide technical assistance to plantation investors; and Government Regulation No. 62/2008, which grants a six-year, 30% net tax deduction to investors in various sectors.

PALM OIL: The world’s undisputed heavyweight champion of palm oil production since it took the title from Malaysia in 2007, Indonesia produced 21.9m tonnes of CPO in 2010 and was forecasting a production increase up to 23.5m tonnes for 2011 according the Indonesian Palm Oil Association (GAPKI).

Palm oil exports for 2010 of 17.09m metric tonnes just edged out the 17.084m metric tonnes exported in 2009 by the slimmest of margins. Of the 2010 total, 15.66m tonnes were derived from palm oils with the remaining 1.43m obtained from kernel oils. Exports were up 8.9% through the first half of 2011, reaching 8.1m tonnes compared to 7.47m tonnes recorded over the same time period the previous year. The rise was attributed by GAPKI to increased demand from primary buyers, including India, China and the EU.

Palm oil production is centred primarily in estates located on Sumatra, representing roughly 70% of the crop’s total production area. The remainder is derived from Kalimantan and a few of the smaller islands.

The primary players in Indonesia’s CPO market are Sinar Mas Agro Resources and Technology, Sime Darby, Astra Agro Lestari, London Sumatra Indonesia, Sampoerna Agro and Bakrie Sumatera Plantations, though many smaller players exist as well, according to Mark Wakeford, the CEO of Indofood Agri. “40-45% of CPO is produced by smallholders,” he told OBG. “This represents a challenge in terms of industry-wide adoption of sustainable and responsible farming.”

TAXES: One recent change to Indonesia’s export tax structure created a stir not just at home but also among other players in the global palm oil market. The decision to reduce the tax cap on CPO exports to a maximum of 22.5% and that of refined palm products to between 13 and 15% was made primarily to boost investment in the downstream palm oil refining industry as well as to reduce cooking oil price volatility.

Because CPO refining operations have much lower margins than direct exportation of CPO abroad, economically viable downstream operations are primarily limited to big internationals which have large upstream sources and substantial capital to see these ventures through. Even then many vertically integrated companies are resistant to increasing downstream output that could possibly eat into upstream profits. The upside for refiners is an export tax that has been nearly halved, which should benefit both demand and profit margins in the future. GAPKI has vocalised its concerns on the matter and has floated the idea of revising the entire tax bracket downward.

“What we suggest is to have the highest tax level on CPO set at 15%, which would still allow for a difference of 10-15% over refined palm oil present under the current tax structure,” Fadhil Hasan, the executive director of GAPKI, told OBG. “We understand the need to stimulate downstream investment, but another way to do this is to abolish downstream tax to zero. The tax would be lower but the difference between crude and refined palm oil would stay the same if we were to apply a tax of 15% on CPO.”

Other suggested alternatives to the existing scheme are a 5% flat tax on CPO. Although considered detrimental by some of the country’s CPO producers, the 2011 measure is not nearly as drastic as the outright ban on CPO exports imposed from December 1997 to March 1998, during the Asian financial crisis. Because of these greater regulatory risks, CPO producers listed on the Indonesian Stock Exchange trade at a discount compared with Malaysian counterparts despite higher profitability levels, according to Helmy Kristanto, a research analyst at BNP Paribas Securities Indonesia.

One overlooked detail in the debate on the revised tax bracket is that while this code provides the framework for tax structure, it is the Ministry of Trade in conjunction with industry officials that actually decides on the export tax rate on a month-to-month basis. This decision is made based on the average spot CPO price on the CIF Rotterdam exchange for the preceding 30 days. Under the new tariff system, average prices will now be calculated on a basket of prices from CIF Rotterdam, Malaysia’s benchmark palm prices and Jakarta palm oil futures. For November and December 2011, the CPO export tax rate was set well below the 22.5% cap at 15%, down from 16.5% in October. In response to the government’s shift to emphasise downstream activity, particularly in the palm oil sector, there has been significant work in the past year to expand the sector’s refining capacity. As of 2010, the country’s total refining capacity was estimated at 24 million tonnes per annum, according to CIMB Investment Bank.

The refining market is currently lead chiefly by large vertically integrated producers, including the world’s largest listed palm oil firm Singapore’s Wilmar and Sinar Mas Agro Resources and Technology (SMART). Both companies have announced plans to significantly boost refining capacity in the near future. Wilmar stated in 2011 its intention to invest some $900m to develop capabilities to produce downstream palm products including soaps and margarine. Likewise SMART also said in March 2011 it will invest approximately $1bn over the next four years to expand its downstream operations. Finally, Procter & Gamble in May 2011 announced a new $100m oleochemical plant to provide the company a supply of fatty alcohol.

STANDARDS: As the global market for palm oil continues to expand, both buyers and producers have struggled to provide a universal framework outlining certification for responsible business practices, a measure especially desired by large international companies operating in Western economies. While much of the international community now recognises the voluntary Roundtable for Sustainable Palm Oil (RSPO), established in 2004, as a credible standard, Indonesia has sought to develop its own certification.

While dozens of Indonesian companies have been RSPO certified, many other firms have refrained, saying the process is too expensive and time consuming. With the bulk of country’s CPO output destined for India and China compared with minimal exports to Europe, incentive to acquire RSPO certification is reduced. As of November 2011, 49 of the 722 RSPO-certified companies were registered in Indonesia.

Indonesia has countered with implementation in August 2011 of the Indonesian Sustainable Palm Oil (ISPO) certification, addressing requirements for a wide variety of environmental issues including plantation licensing and management, cultivation techniques, environmental management and surveillance, and responsibilities to employees and the public at large. In October 2011 GAPKI announced it was backing domestic ISPO standards and would require all members to achieve certification by 2014.

CRITICISM: Indonesia’s rise to the top of the palm oil pyramid and the rapid expansion of its agricultural sector have not been without their detractors. A host of environmental groups and other international nongovernmental organisations (NGOs) condemn government policies designed to make room for increased plantation land, while others decry the demise of the local small-scale farmers whose fragmented and less productive plots are incorporated into larger agricultural estates. As a result, the status quo has shifted as large multinational companies become increasingly image conscious and their shareholders place greater weight on social and environmental impacts in addition to the balance sheet. In recent years both private producers and the government have been forced to address these issues as a number of large international buyers have imposed temporary boycotts on Indonesian supplies after concerns raised questions over some companies’ social and sustainability practices.

The government has yielded to this pressure by implementing stronger conservation policies such as the moratorium on issuing new plantation licences and individual companies have likewise been making strides to clean up their image. For example, in a quick response to market criticism, Singapore-listed Golden Agri Resources (GAR), the parent company of SMART, in early 2011 went about obtaining RSPO certification as well as developing a new forest conservation policy (now regarded as one of the most progressive in the industry) in collaboration with NGO the Forest Trust. As a result of these efforts, both Nestlé and Unilever resumed purchases in October 2011.

But just as the world’s largest food producer resumed business in Indonesia, the world’s largest toy maker, Mattel, cut business ties with Indonesia-based Asia Pulp and Paper (APP) in October 2011 for fibre used in disposable packaging. Mattel claims APP pulpwood suppliers operate in ecologically sensitive areas of Sumatra including endangered tiger habitants. It instituted a new policy of utilising only products certified by the Forest Stewardship Council in its packaging. APP disputed the claim in June 2011, stating its packaging materials contained more than 95% of recycled paper but also announced targets of sourcing only 100% sustainable plantation pulpwood by 2015.

GOING GREEN: One decision made by the government in May 2011 could have a substantial impact on expansion of new land for the agricultural sector over the next two years. The decision, made by presidential decree, has imposed a two-year moratorium on issuing new use permits for primary natural forest and peatland. The decree is part of a larger $1bn partnership with Norway for the purpose of reducing carbon emissions resulting from deforestation (known by the moniker REDD+) and will apply to a total area of between 64m and 72m ha of land.

Despite stiff opposition, the moratorium took effect in late 2011, though a number of exceptions assuaged investors’ concerns considerably. In the moratorium’s current form, plantations can still continue to expand in many areas, because the moratorium excludes secondary forests, forest area release and use permits approved by the Ministry of Forestry: geothermal, oil and gas, electricity, rice and sugar cane development; as well as existing valid forest use permits.

Questions remain as to the effects of the loopholes, the existence of large swaths of permitted land already held by companies but not yet exploited, as well as the interpretation of other ambiguous definitions and clauses contained within the decree. Environmental groups and NGOs have been particularly critical.

RUBBER: Although recently overshadowed by the palm oil industry, Indonesia boasts the largest acreage of rubber plantations of any country on the planet and is the second-largest exporter in the world. The country produced 2.7m tonnes of rubber in 2010, up from 2.4m tonnes produced in 2009 according to the General Federation of Indonesian Rubber Operators ( GAPKINDO). The association’s 2011 production projections are 2.9m tonnes, with 1.74m tonnes achieved through the first half of the year. The association is targeting an output of 3.6m tonnes by 2015.

Unlike other leading plantation crops, the majority of the country’s rubber production is derived from small hold farmers, which make up approximately 86% of all 3.5m ha of cultivated rubber acreage. Rubber cultivation takes place primarily in Sumatra and, to lesser degrees, in Riau, Lampung and Java. The crop is used primarily as a revenue generator, with 90% of production designated for exports and much of the remainder utilised in the domestic automotive sector and other manufacturing industries according to GAPKINDO.

The country is hoping to further boost its output not by drastically increasing the amount of land already in rubber production, but by increasing yields from current levels of 800 kg per ha to about 1.6 tonnes per ha. According to a strategy outlined by GAPKINDO, maturing plantations can be revitalised in part through use of new cloned rubber trees from Malaysia, Java and Vietnam to boost the country’s output to 6m tonnes by 2020. The government employed a similar revitalisation programme from 2007 to 2010 but was largely unsuccessful, mostly due to a variety of bureaucratic difficulties in determining ownership and land usage claims.

OUTLOOK: Indonesia’s large landmass and population as well as its leading global position in terms of exportation of key products including palm oil will ensure the agriculture sector continues to be a major contributor to the nation’s economy. Recent setbacks in some sectors as a result of bad weather and market fluctuations are likely to be temporary, which should lead to a rebound in some commodities such as cocoa. There are also new plans to continue to develop the country’s fisheries sector getting under way (see analysis). Continued strong demand for palm oil and a sector-wide shift towards more downstream operations should both boost employment and increase value-added services. Although Indonesia still has ways to go to develop a strong, unified sustainability policy across the agricultural sector, new legislation continues to move the country forward on this front, brightening prospects.