Government Policies Dean of Graduate School Agricultural Economics

2.2 Government Policies

The government of Indonesia considers agriculture as a very important sector in the national economy. Therefore all agricultural activities like cultivation of rice, maize, spices, rubber, cacao and oil palm are encouraged. Agriculture provides job opportunities for the majority of the labor forces in Indonesia. At the same time, the government makes efforts to maintain the prices of basic goods and services at levels affordable to low-income people. Basic needs are mainly for food and clothing. Cooking oil also falls in this category. Therefore the price of cooking oil has to remain at an affordable level. When the price of palm oil in the international market went up in 1994, the price of cooking oil in domestic market experienced a similar increase. In order to lower the price of cooking oil, the government applies export tax on crude palm oil and refined products. By export tax, the local price of the crude palm oil can be brought down to a level which is considered affordable. When the price was not excessively high, the tariff of the export tax was around 15 percent Bangun, 2006. However, when in 1998 the international price of palm oil reached US 600 per metric ton CIF Rotterdam and the Indonesian currency suffered a dramatic weakening of its exchange rate, the tariff of the export tax was increased to 40 percent. Even such a high export tax was not sufficient to bring the local price of cooking oil to the expectation of the public. So, the government further increased the tax to 60 percent. As a result, the exporter of palm oil received only US 240 per ton after a deduction of US 360 as export tax Bangun, 2006. Subsequently, the price of palm oil in international market declined and the Indonesian currency achieved a better exchange rate. The government agreed to reduce the export tax to 30 percent, then to 10 percent, followed by 5 percent, and subsequently to levels as shown in Table 1 Bangun, 2006. In a new regulation issued on September 10, 2005, the export tax is called “export collection” which is categorized as non tax revenue by the government. It can be easily calculated that the export of crude palm oil is subject to export collection as much as US 5.25 per ton, and for RBD Olein US1.14 per ton. Table 1. Indonesian Crude Palm Oil Export Tax in the Year 1997 to 2007 From To CPO Export Tax December 1997 5 December 1997 January 1998 30 January 1998 April 1998 April 1998 July 1998 40 July 1998 February 1999 60 February 1999 June 1999 40 June 1999 July 1999 30 July 1999 September 2000 10 September 2000 February 2001 5 February 2001 December 2002 3 December 2002 June 2007 1.5 June 2007 To date 6.5 Source: BPS, 2007. Since the policy implementation in August 1994, this export tax policy has had significant impact on the industry. Within the time horizon 1994-1999 when the effective tax rate was around 13.33 percent, the mature area of oil palm plantation had been reduced by 2.56 percent per annum or around 37 000 ha per annum as reported in Table 2. This indicates that this policy had a substantial negative effect on investment in the industry. As a result of this negative investment effect, CPO production had also been depressed by the policy. It is estimated that the policy had caused a loss of around 0.81 percent of the total production or around 36 000 tons of CPO per annum. Table 2. Impact of Export Tax of Crude Palm Oil in the Year 1994-1999 Variable Units Mean Impact in percent Impact in volume Mean Mature Area 000’ ha 1445.00 -2.56 -37.00 Production 000’ tons 4484.00 -0.81 -36.32 Export 000’tons 2371.00 -6.20 -147.00 CPO Price Rpkg 1525.00 -8.58 -130.85 Cooking Oil Price Rpkg 2366.85 -7.77 -183.90 Source: Susila, 2004. The most devastating impact of the policy had been on the export and farm income. During that time horizon, this policy had caused a 6.02 percent drop in exports compared to the pre-export tax period. This implies that Indonesia had sacrificed her export of about 147 000 t annually. Similarly, the policy had caused the farm income to be lower by around 11.35 percent or around Rp 400 000hayr; a substantial loss for farmers. On the other hand, this policy had been proven to be effective in controlling domestic cooking oil price. With this policy, the government had been successful to keep the cooking oil price down when the world CPO price increased or when the rupiah was substantially depreciated. Using this policy, the government had kept the cooking oil price at 7.77 percent, or Rp 184kg, lower than it should be. Moreover, from the government point of view, significant tax revenue, estimated at around Rp 5241 billion, was also considered to be a positive result of the policy Susila, 2004. The reference price was to be adjusted monthly based on the actual prices in Rotterdam and Kuala Lumpur. With regard to laws and regulations and the objective of achieving good governance, both the government and the parliament promulgated laws on forestry and plantations. The law on forestry No.41 was promulgated in 1999 and the law on plantations No.18 was promulgated only recently in 2004. These two laws greatly restrict the conversion of forest into oil palm plantation. Only certain forests can be converted into plantation. With these new laws already in place, the government has been taking measures to enhance the protection of forest and as well as endangered animals.

2.2.1 Effects of Export Tax

Export taxes are predominantly used by developing countries with the objective either to generate government revenues or to protect particular groups for political reasons. The effect of an export tax by a small country under a competitive market structure causes the price in the exporting country to fall below the world price Reed, 2000; McCalla and Josling, 1985. Empirical studies on the effect of export taxes have been conducted by Akiyama 1992, Bruce and Perez-Garcia 1992 and Warr 1997. Akiyama 1992 examined the effect of an optimal tax on perennial crops cocoa in a large country case. In particular, his research focused on an optimal export tax and its implications on producer surplus and government reserves. His results showed that an export tax significantly affected the distribution of national welfare between farmers and the government, and also significantly affected the long-run production of cocoa. Bruce and Perez-Garcia 1992 examined the economic impact of a USA export tax on forest products using a competitive global trade model. Their results showed a loss of consumer welfare in the USA and a large transfer of wealth from timber growers to processors. Warr 1997 conducted a similar study on Thailand’s rice export tax and calculated economic gains and losses.

2.2.2 Effects of Export Tax on Indonesian Crude Palm Oil

From the previous studies, Mohamad et al. 2001 found out that Indonesian palm oil’s net export shares fell by 44.5 percent in October 1994 after the implementation of the export tax in September 1994. The effect of the export tax on Indonesian palm oil reached a peak in December 1994, when it reduced net export shares by 64.4 percent. The export tax was quite variable during the September 1994 through December 1997 period, but model results made it clear that the export tax had tremendous impacts on palm oil exports from Indonesia. Clearly, the export tax policy reduces not only competitiveness of the Indonesian palm oil industry but also hurts producers of CPO, some of them are small-holder farmers, due to the lower price of CPO relative to the world market price. On the other hand, refiners that process CPO into various products such as cooking oil, margarine, shortening gain from this policy since they get CPO at lower prices Mohamad et al., 2001 . Finally, consumers may or may not gain from this policy since there is no guarantee that the processors will pass on the lower price of cooking oil. Considering that the concentration ratio in this industry is large, which indicates a potential oligopolistic market structure; it is not likely that the consumers fully benefit from the lower price of cooking oil. The export tax policy also hinders the development of the cooking oil industry in Indonesia as a whole and does not encourage diversification in cooking oils. The major sources of cooking oil in Indonesia are coconut oil, which is made from CCO crude coconut oil, and RBD refined, bleached, deodorized Olein, which is made from CPO. These two products are close substitutes so that policies imposed on one commodity will have tremendous effects on the other commodity. The imposition of an export tax diverts CPO from the export market to the domestic market, lowering all cooking oil prices. This causes more competition with the domestic coconut oil industry, which otherwise would provide the supply more of the raw material for domestic cooking oil Soeherman, et al., 2006. Considering that significant amounts of copra, the raw material of coconut oil, are made from coconuts that come from small-holder farmers, the export tax policy on CPO could further lower price of coconuts and pressure farm incomes. In light of the current economic crisis, the export tax policies discourage the country’s recovery effort. Under current exchange rates, there is an opportunity to increase Indonesia’s industrial export competitiveness to achieve economic recovery. Improved competitiveness will benefit not only economic growth but also overcome the bias against the rural and agricultural sectors which has been associated with previous growth spurts. Thus, agricultural exports should be encouraged at all costs. The implications are that taxes and non-tax barriers to export should be removed if the potential gains from export are to be realized. By imposing an export tax on CPO, the government creates an impediment to increasing agricultural exports and competitiveness of the export-oriented industry.

2.2.3 Export Performance of Indonesian Crude Palm Oil

Export value of Indonesian CPO in 1999 was US 118.37 million and in 2005 increased to US 493.39 million that contributed to 36.24 percent growth rate per year. Indonesia CPO faces competition from Malaysia in the international market. During the same period, in 1999, Malaysia exported CPO worth US 311.46 million while in the year 2005 it received US 814.063 million from CPO exports that represents 21.29 percent growth rate Siregar and Sinaga, 2006. Source: Tambunan, 2006 Figure 1. Revealed Comparative Advantages of Malaysia and Indonesia for Crude Palm Oil, Year 1996-2002 Tambunan 2006 used Revealed Comparative Advantage RCA Index according to the Balassa formula. Based on data from the Ministry of Industry Deprindag, Figure 1 above shows the RCAs of Indonesia and Malaysia as reported by Tambunan, 2006, which indicated that Malaysia is indeed the heaviest competitor for Indonesia in palm oil trade, as in most years the RCA of Malaysia is higher than that of Indonesia. The export performance index of CPO RCA of Indonesia and Malaysia in the period 1999 to 2005 had values greater than one RCA1. RCAI of Indonesia in China’s market in the year 2005 was 1.29 while Malaysia had a value of 1.66 as shown in Table 3, showing that Malaysia and Indonesia at that time had comparative advantage in exporting CPO to China. In comparison of revealed comparative advantage index per year, the export performance of Malaysian CPO was higher than that of Indonesia Siregar and Sinaga, 2006. 5 10 15 20 25 30 35 40 45 1996 1997 1998 1999 2000 2001 2002 RCA Year Malaysia Indonesia Table 3. Revealed Comparative Advantage of Malaysia and Indonesia in China Crude Palm Oil Market in the Year 1999 to 2005 Year Malaysia Indonesia 1999 1.88 1.76 2000 1.58 1.47 2001 1.33 1.05 2002 1.61 1.40 2003 1.82 1.62 2004 2.00 1.73 2005 1.66 1.29 Source: Siregar and Sinaga, 2006. Simeh 2004 found that Indonesian CPO has comparative advantage like Malaysian CPO because of the low cost of producing CPO in Indonesia US 165.2 per ton compared to that of Malaysia that costs US 239.4 per ton. With uniform price of US 433.0 per ton gives a profit margin between production cost and price of CPO of US 277.8 for Indonesia which is higher as compared to that of Malaysia that gets US 203.6 per ton Siregar and Sinaga, 2006.

2.2.4 Government Subsidies

The Indonesian government has lessened the burden on the industry by cutting export tax to 3 percent. However government gives no cash subsidy or equivalent incentives, and allows market forces of supply and demand to govern the price of palm oil paid to the producer Howard, 2001. This is also the case in Malaysia, although there is recognition that the current CPO market price paid to smallholders is insufficient to maintain a reasonable standard of living. As a result there is a proposal from the Malaysian government to pay an incentive of 260 per planted hectare to both smallholders and to estates that re-plant palms over 25 years of age. In contrast, fat and vegetable oil producers in the United States and Europe are subsidized. The United States Department of Agriculture USDA provided 28 billion to its farmers and ranchers in the financial year 1999-2000, equivalent to almost half of total farm income. An additional 500 million ‘emergency assistance’ was available in 2000 to 600 000 producers of oil seed canola, flaxseed, mustard, rapeseed, safflower, sesame, soybean and sunflower. Further cash is available to all farmers if natural disasters cause losses. Within the European Union the producers of rapeseed received a subsidy of 46 percent of their production costs. The spirit of the World Trade Organization agreements to stop farming subsidies is clearly being broken to the detriment of the Indonesian and Malaysian producers of palm oil.

2.3 Status of Indonesian Palm Oil Industry