The Price Transmission in Rice Market Chain in Indonesia

THE PRICE TRANSMISSION

IN RICE MARKET CHAIN IN INDONESIA

HUSNUL KHOTIMAH

GRADUATE SCHOOL

BOGOR AGRICULTURAL UNIVERSITY BOGOR

STATUTORY DECLARATION AND COPYRIGHT DELEGATION

I hereby declare that my thesis entitled “The Price Transmission in Rice Market Chain in Indonesia” is true of my work as under the guidance of the advisory committee and it has not been submitted in any form to any institution. This is submited to fulfill one of the requirements for the award of Master of Science from Bogor Agricultural University Indonesia and Georg-August Goettingen University Germany in the frameworks of international joint degree program between both universities. The source of informations derived or quoted from published and unpublished works from other authors have been mentioned in the text and listed in the References at the end of this thesis.

I hereby assign the copyright of my writing to Bogor Agricultural University.

Bogor, January 2013 Husnul Khotimah NIM H451100201

ABSTRACT

HUSNUL KHOTIMAH. The Price Transmission in Rice Market

Chain in Indonesia. Supervised by SUHARNO, RITA NURMALINA,

and STEPHAN VON CRAMON-TAUBADEL.

The aim of this study is to assess the rice market chain performance, namely price volatility and price transmission among producer, rice miller, wholesaler, and retailer, with respect to the enforcement of rice price stabilization policy in Indonesia. We use the standard deviation of return for price volatility and the Cointegration test and the Error Correction Model for price transmission analysis. The results of this study show that the magnitudes of price volatilities along market chain decrease from producer to retailer. Producer in the upstream faces the highest price volatility at 24,9%, and then ricemiller and wholesaler face the lower price volatility than producer but still high at 18,3% and 18,1%, respectively. Whereas retailer in the downstream faces the stable price at 8,7%. The price transmission analysis concludes that the rice market chain in Indonesia is segmented. The rice price is not transmitted completely from producer to consumer, and vice versa. There are only two markets which are integrated, namely price relationships between producer and ricemiller and between wholesaler and retailer. Meanwhile the price relationships between producer and wholesaler, producer and retailer, ricemiller and wholesaler, and ricemiller and retailer are not integrated.

SUMMARY

HUSNUL KHOTIMAH. The Price Transmission in Rice Market Chain in Indonesia. Supervised by SUHARNO, RITA NURMALINA, and STEPHAN VON CRAMON-TAUBADEL.

Rice commodity has important and strategic roles in Indonesia economically, socially, and politically. Therefore the government of Indonesia imposes comprehensive policies to maintain rice price to be stable. The performance of its policies can be seen from Indonesian rice market resilience faced the world rice crisis in 2007/2008. The Indonesian rice market policy for price stabilization is executed by Bulog. Bulog has tasks to import rice, purchase domestic excess supply, maintain government rice reserve, inject additional supply when rice price rise, and distribute rice for the poor with low price. The successful of price stabilization policy in Indonesian rice market raise a question how did this policy influence the rice market chain performance? especially price volatility and price transmission among producer, rice miller, wholesaler, and retailer. We use the standard deviation of return for price volatility and the Cointegration test and the Error Correction Model for price transmission analysis.

The result of this study shows that the magnitudes of price volatilities along market chain decrease from producer to retailer. Producer faces the highest price volatility at 24,9%, and then rice miller and wholesaler face the lower price volatility than producer but still high at 18,3% and 18,1%, respectively. Whereas retailer faces the stable price at 8,7%. This study also confirms that the rice price volatilities before and during crisis are not different significantly for retailer price, wholesaler price, and rice miller price, but decrease significantly for producer price.

The price transmission analysis concludes that the rice market chain in Indonesia is segmented. The rice price is not transmitted completely from producer to consumer, and vice versa. There are only two markets which are integrated, namely price relationships between producer and rice miller as well as wholesaler and retailer. Whereas the price relationships between producer and wholesaler, producer and retailer, rice miller and wholesaler, and rice miller and retailer are not integrated. The factors which may influence these relationships are the seasonal price effects, market power to manage supply, trade barriers, direct or indirect interaction related to product flows effects on price determination, transaction costs, transparancy of market information, and price stabilization policy.

The policy implications which can be recommended from this study are: manage the unstable supply from production point through manage the cropping pattern in the production areas and strengthen the farmers’ institution by reinforce

“Lumbung Padi” to the farmers, provide and manage good infrastructures for

transportation, rice processing, warehousing, and communication infrastructure in Indonesian rice market chain system, encourage the market competitiveness along the rice market chain, and if everything is going well the rice price stabilization policy in the downstream market may be omitted.

RINGKASAN

HUSNUL KHOTIMAH. Transmisi Harga pada Rantai Pasar Beras di Indonesia. Dibimbing oleh SUHARNO, RITA NURMALINA, dan STEPHAN VON CRAMON-TAUBADEL.

Komoditas beras memiliki peran yang penting dan strategis bagi Indonesia, baik secara ekonomi, sosial, maupun politik. Maka dari itu pemerintah Indonesia menerapkan kebijakan yang komprehensif untuk menjaga harga beras tetap stabil. Kebijakan ini dinilai berhasil menghadapi krisis pangan global pada tahun 2007/2008. Kebijakan stabilisasi harga beras di Indonesia dilakukan oleh Bulog. Keberhasilan kebijakan stabilisasi harga beras di pasar Indonesia menimbulkan pertanyaan bagaimana kebijakan ini mempengaruhi kinerja rantai pasar beras, khususnya volatilitas harga dan transmisi harga antara petani, penggilingan, grosir, dan ritel. Penelitian ini menggunakan standard deviation of return untuk analisis volatilitas harga serta Cointegration test dan Error Correction Model untuk analisis transmisi harga.

Hasil dari penelitian ini menunjukan bahwa besar volatilitas harga beras sepanjang rantai pasar menurun dari petani ke ritel. Petani menghadapi volatilitas harga yang paling tinggi dengan volatilitas harga 24,9%, kemudian penggilingan dengan 18,3%, grosir dengan 18,1%, dan ritel dengan 8,7%. Ritel menghadapi harga yang stabil dibandingkan dengan lembaga pemasaran lainnya. Penelitian ini juga mengkonfirmasi bahwa volatilitas harga sebelum dan selama krisis tidak berbeda signifikan untuk harga penggilingan, harga grosir, dan harga ritel. Tapi menurun dengan signifikan untuk harga petani.

Analisis transmisi harga menyimpulkan bahwa rantai pasar beras di Indonesia tidak terintegrasi. Harga beras tidak tertransmisikan secara sempurna dari petani ke ritel, dan begitu juga sebaliknya. Hanya ada dua pasar yang terintegrasi yaitu antara petani dengan penggilingan dan grosir dengan ritel. Sementara itu pasar antara petani dengan grosir, petani dengan ritel, penggilingan dengan grosir, dan penggilingan dengan ritel tidak terintegrasi. Faktor-faktor yang diduga mempengaruhi hubungan transmisi harga ini antara lain dampak dari harga musiman, kekuatan pasar dalam mengelola penawaran, hambatan-hambatan perdagangan, hubungan interaksi langsung atau tidak dalam perdagangan terkait dengan dampak dari aliran produk dalam penentuan harga, biaya-biaya transaksi, transparansi informasi pasar, dan kebijakan stabilitas harga.

Implikasi kebijakan dari penelitian ini adalah: mengupayakan suplai produksi yang stabil melalui mengelola pola tanam di daerah produksi dan memperkuat kelembagaan petani dengan menggalakan kembali lumbung padi, mengediakan dan mengelola infrastruktur dengan baik dalam bidang transportasi, penggilingan beras, pergudangan, dan infrastruktur komunikasi dalam sistem rantai pasar, mendorong pasar yang kompetitif sepanjang rantai pasar, dan jika semuanya sudah berjalan dengan baik, kebijakan stabilisasi harga beras di hilir rantai pasar beras bisa dihilangkan.

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THE PRICE TRANSMISSION

IN RICE MARKET CHAIN IN INDONESIA

HUSNUL KHOTIMAH

A Thesis

as one of the requirements to achieve the title of Master of Science

on Study Program of Agribusiness

GRADUATE SCHOOL

BOGOR AGRICULTURAL UNIVERSITY BOGOR

Examiner from External Committee : Dr. Amzul Rifin, SP, MA. Examiner from Program Study : Dr.Ir. Netty Tinaprilla, MM

Thesis Title : The Price Transmission in Rice Market Chain in Indonesia

Name : Husnul Khotimah

Registration Number : H451100201

Approved

1. Advisory Committee

Dr. Ir. Suharno, M.Adev Chairman

Prof. Dr. Ir. Rita Nurmalina, MS Member

Prof. Dr. Stephan von Cramon-Taubadel Member

Agreed

2. Coordinator of Major Agribusiness 3. Dean of Graduate School

Prof. Dr. Ir. Rita Nurmalina, MS Dr. Ir. Dahrul Syah, M.Sc.Agr

ACKNOWLEDGEMENT

I would like to express my gratitude to my supervisors in Bogor Agricultural University Indonesia, Dr. Ir. Suharno, M.Adev and Prof. Dr. Rita Nurmalina, MS, for their motivation, encouragement, and assistance to learn about rice market in Indonesia. I hope my research can give additional insight about how price transmission works in the Indonesian rice market.

I would also like to thank to my supervisor from Georg-August Goettingen University Germany, Prof. Dr. Stephan von Cramon-Taubadel for the continuous support in my research, for his patience, motivation, discussion, answer and immense knowledge. His guidance helped me to learn the basic of price transmission theory and encourage me to learn more and write my thesis with spirit. My thanks also for Nelissa Jamora for her help, discussion, and motivation to finish my thesis.

My big gratitude for my big family in Kuningan West Java, especially for my mom, my dad, and my fiance, who allowed me to continue my study in Germany, for their prays, supports and smiles every day for me. My thanks also for my friends in Magister Science of Agribusiness AK 1 and for my new family in Germany, Roko Big Family. Thank you for togetherness, happiness, and familiarity accompanying my study in Bogor and Goettingen.

I must also acknowledge Indonesia-Germany Scholarship Program from Directorate General of Higher Education, The Ministry of National Education Republic of Indonesia, for their finance and trust given to me to study in Germany.

Bogor, January 2013 Husnul Khotimah

BIBLIOGRAPHY

The author was born in Kuningan, June 19th 1987. She is the third of four children from Mr. Lumri Rais and Mrs.Aah Sariah. She grew up and study from elementary school until senior high school in Kuningan West Java. She finished her senior high school in SMAN 1 Mandirancan, Sub district Kuningan West Java. She continued her study in Bogor Agricultural University with major Agribusiness and graduated as the Bachelor of Economics in 2010. Then she continued her master immediately in the same year on International Joint Degree Program between the Magister Science of Agribusiness, Graduate School of Bogor Agricultural University Indonesia and the International Agribusiness and Rural Development, Sustainable International Agriculture, Georg-August Goettingen University Germany with sponsorship from the Directorate General of Higher Education, The Ministry of National Education Republic of Indonesia.

TABLE OF CONTENTS

Page

TABLE OF CONTENTS ... xiv

LIST OF TABLES ... xv

LIST OF FIGURES ... xvi

LIST OF APPENDIXES ... . xvii

ABBREVIATIONS ... xviii

I INTRODUCTION ... 1

1.1 Background ... 1

1.2 Problem Statement ... 4

1.3 Objectives of Study ... 5

1.4 Scope of Study ... 5

1.5 Organization of Study ... 5

II THE INDONESIAN RICE MARKET ... 7

2.1 Production, Consumption, and Import ... 7

2.2 Rice Policies in Indonesia ... 11

2.3 Indonesian Rice Market Chain ... 14

2.4 Previous Studies on Rice Price Transmission in Indonesia ... 16

III THEORETICAL BACKGROUND ... 19

3.1 Price Volatility and Price Stabilization Policy ... 19

3.2 Price Transmission and Market Integration ... 22

3.3 Operational Framework ... 24

IV METHODS ... 27

4.1 Data and Sample Collecting Method ... 27

4.2 Data Processing and Analysis Method ... 27

4.2.1 Volatility Analysis ... 27

4.2.2 Price Transmission Analysis ... 28

V RESULTS AND DISCUSSION ... 33

5.1 Rice Price Volatilities ... 33

5.2 Rice Price Transmission and Market Integration ... 34

5.2.1 Unit Root Test ... 34

5.2.2 Cointegration and Error Correction Models ... 36

5.3 Discussion and Policy Implications ... 46

VI CONCLUSION AND RECOMENDATIONS ... 51

6.1 Conclussion ... ... 51

6.2 Recomendations ... 52

REFERENCES ... 53

LIST OF TABLES

Table Page

1 Harvested area, production, and yield of rice in Indonesia in

2000-2012 ... 9

2 Harvested area, production, and yield of rice per province in 2011 ... 10

3 The price volatilities of producer, rice miller, wholesaler, and retailer 33 4 Unit Root test result ... 35

5 Cointegration test for producer-rice miller ... 36

6 Error Correction Model for producer-rice miller ... 37

7 Cointegration test for producer-wholesaler ... 38

8 Error Correction Model for producer-wholesaler ... 39

9 Cointegration test for producer-retailer ... 40

10 Error Correction Model for producer-retailer ... 41

11 Cointegration test for rice miller-wholesaler ... 41

12 Error Correction Model for rice miller-wholesaler ... 42

13 Cointegration test for rice miller-retailer ... 43

14 Error Correction Model for rice miller-retailer ... 44

15 Cointegration test for wholesaler-retailer ... 44

16 Error Correction Model for wholesaler-retailer ... 45

LIST OF FIGURES

Figure Page

1 Comparison of rice prices between Indonesia, Thailand, and

Vietnam in 2005-2010 ... 2

2 Comparison of rice production and consumption in Indonesia .... 7

3 Indonesian rice import in 2000-2012 ... 8

4 Seasonal paddy crop calendar ... 11

5 Rice market chain in Indonesia ... 15

6 Conventional analysis of supply-induced price variability ... 20

7 The enforcement of floor price to stabilize price in the market ... 21

8 The enforcement of government purchasing price to stabilize price in the market ... 21

LIST OF APPENDIXES

Appendix Page

1 F-test for test the significance of variance differences

of rice prices before and during crisis ... 58 2 Graph of producer price and rice miller price in

2000-2012 ... 58 3 Graph of producer price and wholesaler price in

2000-2012 ... 59 4 Graph of producer price and retailer price in

2000-2012 ... 59 5 Graph of rice miller price and wholesaler price in

2000-2012 ... 60 6 Graph of rice miller price and retailer price in

2000-2012 ... 60 7 Graph of wholesaler price and retailer price in

ABBREVIATIONS

ADF Augmented Dickey Fuller AIC Akaike Information Criteria

BPS Badan Pusat Statistik (Statistics Central Board)

BULOG Badan Urusan Logistik (National Logistics Board) ECM Error Correction Model

FAO Food and Agricultural Organization FAS Foreign Agricultural Service

GDP Gross Domestic Product

HPP Harga Pembelian Pemerintah (Government Purchasing Price)

IFAD International Fund for Agricultural Development IMF International Monetary Fund

LOI Letter of Intent MP Rice Miller price

MT Million Ton

PP Producer Price

RASKIN Beras untuk masayarakat miskin (Rice for the poor) RP Retailer Price

SD Standard Deviation of Return

USDA United States Department of Agriculture WP Wholesaler Price

I INTRODUCTION

1.1 Background

“Pangan Rakyat adalah Soal HIDUP ATAU MATI”

“Food for People is about LIFE OR DEATH”

Soekarno, First President of Indonesia. Bogor, 27 April 1952

This quote is the title of President Soekarno’s speech in the cornerstone -laying ceremony for the Faculty of Agriculture in the University of Indonesia (now Bogor Agricultural University). This quote emphasizes the important of food for people, especially rice for Indonesian people. He also stated that to provide sufficient amount of rice and maintain affordable rice price for people are the important things to maintain the economic stabilization in the country. Many efforts to depress other prices are nothing when rice price is not stable and not affordable (Soekarno 1952).

Rice price has important role for Indonesia with respect to poverty, economic growth, and food security. The level of rice price is the most important determinant of poverty at household level in the short-run. The Indonesian households spent about 10% of their income and the poor households spent about 20-25% of their income to buy rice. The consumption per capita of rice in Indonesia is the 3rd highest in the world; it is about 139,1 kg/year/person. The unaffordable and unstable rice price brings the disaster for the poor. The poor always bear the brunt of bad economics, and then this condition inhibits the poverty alleviation (Timmer 2004).

In addition, rice commodity has strategic roles both economically, socially, and politically. In January 2012, the national inflation was at 0,76% and rice contributed by 0,18% (BPS 2012). The inflation of rice price will trigger the other goods prices. The severe high prices of food can trigger the riot of society and disrupt the stabilization of politics. Even it can drop the government power. This situation has occurred in Indonesia, when multi crisis hit Indonesia in 1998.

The food crisis in the world market occurred twice in the last decade . The first crisis took place in 2007/2008 and the second crisis in 2010/2011. The food prices increased slowly and steadily before, then in the beginning of 2007 food prices took off and reached its peak in the mid of 2008 (FAO 2011). The staple food prices surged significantly in the world market in this period, for examples maize price increased by 74%, wheat price increased by 124%, and rice price increased by 224% (World Bank 2008). Further, after mid 2008 food prices declined but then increased again in 2010 and reached its recorded peak in February 2011 (FAO Global Food Price Monitor 2011).

The high food prices have severe implications for food and nutrition security, macroeconomic stability, and political security (Braun 2008). Data from FAO (2008) show that the number of undernourished people increased from 848 million in 2005 to 963 million in 2008 due to the food crisis. The food crisis in 2007/2008 affected the economic growth of many developing countries which active as exporter and importer in the world rice market. The economic growth of these countries were dropped to negative rate, for example, in 2008 the economic growth of Singapore at -8,9%, Thailand at -7,11%, Malaysia at -6,2%, and the Philippines still had positive economic growth with declining growth rate (World Bank in Tambunan 2010).

Figure 1 Comparison of rice prices between Indonesia, Thailand, and Vietnam in 2005-2010 period

On the contrary Indonesia had positive economic growth at 6,2%, though then it declined into 5,2% in the last quarter of 2009. Many studies conclude that the food crisis in 2007/2008 did not affect Indonesian economy, especially in the rice market. The high price of rice in the world market was not transmitted into the rice price in Indonesia (Timmer 2008; BAPPENAS 2009; Keats et al. 2010; Tambunan 2010; Dawe 2011). The rice production performed well in 2007. It can provide enough rice stock and injection of rice supply for domestic market. In addition the government of Indonesia also controlled on quantity of rice traded internationally with trade restrictions (Dawe 2011). One of the government efforts to prevent the rice selling to abroad and also in order to maintain its stock is by announced the ban policy on rice export early in 2008 before the peak of rice harvest time (Timmer 2008). Bulog as the state enterprise, whose role to stabilize the rice price, has managed well the excess supply from production and maintain the rice supply to meet demand in the rice market. Therefore, the rice price was stable with normal inflation in Indonesia (BAPPENAS 2009).

The price transmission occurs when the price changes in the one market of any given commodity similarly reflected in the other market in different location (spatially) or other level in the market chain (vertically), transaction costs and marketing margin are assumed not be counted. One of the requirements for price transmission is that the policies are not an obstacle for market (Keats et al. 2010). Whereas, the government of Indonesia imposes many of the rice policies to maintain stable rice price through maintain the stock, regulate the rice import, purchase the excess supply of harvest from producer, inject rice supply into market when supply from producer is shortage, and distribute rice for the poor with low price. Bulog has the right to execute these policies. These policies will influence the price determination in the rice market either directly or indirectly.

The other factors which influence price transmission is market power. In the developing country such as Indonesia, the bargaining powers among market institutions in the rice market chain are not equal. Farmers as producer have the weakest bargaining power in the market chain due to the lack information about market and the need for immediate cash after harvest time. Most of them cannot hold their products to wait for the better price. They always sell their harvest

immediately in harvest time with given price. The equilibrium price in harvest time is low due to the abundant supply in the market (Bustaman 2003). Farmers are the net consumer for rice. Mostly farmers sell their product in unhusked form, without storing the stocks for their need. The low revenue from rice production implies the difficulties to buy their living needs, even for rice.

1.2 Problem Statement

The resilience of Indonesian economy in the rice price crisis in 2008 gave benefit for domestic consumer with stable rice price. But how does this stable price in the retail market impact the other market institutions in the rice market chain? Does the rice price in retail market transmit to the wholesaler price, the rice miller price, and the producer price? We can measure price transmission in the market chain to see how the market chain’s performance and the market efficiency during the period of price stabilization policy. The magnitude of price transmission is important because it will affect the extent of adjustment by market institutions in the market chain to stabilize price movements. In addition, the prevailing price obtained by each level influences their welfare (Timmer 2008).

The rice price volatilities in each level of market chain are also important to see, because the price volatility of rice might dampen the potential benefit of higher price for the market institutions in the market chain by increasing the uncertainty and distorting the economic planning (Braun 2008). In the short-run, the price volatility increases risk and vulnerability for producer, rice miller, wholesaler, and retailer in the market chain by mystify the market signals and overcomplicate the decision making process (IFAD 2010 in UK Hunger Alliance 2011).

The government of Indonesia has intervened the rice market through variety of policy instruments. These interventions very likely influence the market performance, especially the price transmission process. This study wants to find how the government interventions influence the market performance of the Indonesian rice market chain, especially the price volatility and the price transmission. Thus the research questions of this study are:

1) How volatile are rice prices of producer, rice miller, wholesaler, and retailer?

2) How are the rice price transmissions between producer, rice miller, wholesaler, and retailer in the rice market chain of Indonesia?

3) What are the policies implications from this study for the government of Indonesia?

1.3 Objectives of Study

The objective of this research is to assess the market performance of rice market chain in Indonesia namely the price volatility of rice and the extent of market integration and price transmissions between producer, rice miller, wholesaler, and retailer in Indonesian rice market chain. This study also analyzes the policy implications of this study.

1.4 Scope of Study

The scope of this study is the price volatility analysis and the price transmission analysis among producer, rice miller, wholesaler, and retailer in the rice market chain of Indonesia. This study uses secondary data of national average rice price at each level in monthly series data from January 2000 until May 2012. This period is taken for analysis relates to the period of new intervention approach by the government of Indonesia to maintain stable price in the rice market. This study uses standard deviation of return, Cointegration test, and Johansen Maximum Likelihood Error Correction Model. The data processing uses Excel and Jmulti Software.

1.5 Organization of study

The organization of this study is structured as follows. Chapter 1 describes the background of this study, the problems, the objectives, the scope of study, and the organizations of study. Chapter 2 describes the condition of Indonesian rice market. Chapter 3 explains the literature reviews about theory and the framework of this study. Chapter 4 details the methods of this study. Chapter 5 presents the

results and discussion. Chapter 6 concludes this study with conclusion, policy implications, and recomendations based on this study.

II THE INDONESIAN RICE MARKET

2.1 Production, Consumption, and Import

Indonesia is the 3rd biggest rice producer country in the world which contributes about 7,85% of the world rice production, but in the same time as the 6th biggest rice importer which imported 1,25 MT in 2011/2012 or about 3,41% of total world production (FAS USDA 2012). Indonesian rice production is lower than its consumption. This condition makes Indonesia as a net importer of rice in world market, after experienced successful green revolution and self-sufficiency achievement in 1980s.

The rice production growth is hindered by the lack of production land due to land conversion of arable land to non-agricultural uses such as industry and settlement. Especially in Java as the most fertile land as well as the highest land value compared to other major islands. The land rent for industry and settlement purposes are about 500 and 622 times to land rent for agricultural purposes, respectively (Nasoetion & Winoto 1996 in Kusumaningrum 2008). Therefore many farmers sell their land or convert their land for building industry or settlement.

Figure 2 Comparison of rice production and consumption in Indonesia Source: FAS USDA 2012

0,000 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000

Table 1 shows that rice production has constant trend for 2000-2012 period. The rice production in 2012 is 32,17% higher than in 2000. Even though the rice production increase, the consumption of rice increase higher. Therefore there is a gap between rice production and rice consumption. This gap is compensated by importing rice from world market. Indonesia has been importing rice from Thailand and Vietnam since the 1998 crisis. The rice import of Indonesia since 2000 to 2012 has a declining trend. Even in the period of crisis in 2007-2010, Indonesia imported less than 0,5 MT.

Figure 3 Indonesian Rice Import in 2000-2012 Source: FAS USDA 2000-2012

The Indonesian rice production increases steadily because the harvested area also grow steadily. In 12 years the harvested area only increase 13,97% and the national average for yield also not really significant increase. The yield in 2012 is still at 5,1 ton/ha, it is under the ideal yield at 8 ton/ha. The lack of harvested area needs the enhancement of yield to compensate it. The enhancement of yield still difficult for Indonesia, there are still many problem to be solved. The encouragement of new technology to produce higher yield and more stable production along the year are needed. The extention program for farmers to use new technology also needs to do continuously and massively to support the enhancement of yield and rice production in Indonesia.

0,000 0,500 1,000 1,500 2,000 2,500 3,000 3,500 4,000

Table 1 Harvested area, production, and yield of rice in Indonesia in 2000-2012 Year Harvested Area

(Ha)

Production (Ton)

Yield (Ton/Ha)

2000 11.793.475 51.898.852 4,40

2001 11.499.997 50.460.782 4,39

2002 11.521.166 51.489.694 4,47

2003 11.488.034 52.137.604 4,54

2004 11.922.974 54.088.468 4,54

2005 11.839.060 54.151.097 4,57

2006 11.786.430 54.454.937 4,62

2007 12.147.637 57.157.435 4,71

2008 12.327.425 60.325.925 4,89

2009 12.883.576 64.398.890 4,99

2010 13.253.450 66.469.394 5,02

2011 13.203.643 65.756.904 4,98

2012 13.440.940 68.594.067 5,10

Source: BPS 2012

The rice self-sufficiency of Indonesia always above 90%, it means the domestic consumption needs almost can be met by domestic rice production. More than half of the national rice production is contributed by Java Island as the most fertile land and the biggest farm labor forces. Java produces about 2,5 MT per year or about 52% of the national rice production. The other islands like Sumatera, Sulawesi, Kalimantan, and Bali with Nusa Tenggara contribute 24%, 11%, 7%, and 5% of the national rice production, respectively. The major rice producing areas are West Java, East Java, Central Java, South Sulawesi, and North Sumatera. In other hand for the other islands such as Kalimantan, Papua, Maluku, and small islands are not suitable to be planted by paddy. They only contribute by 1% of national production (BPS 2012).

Table 2 Harvested area, production, and yield of paddy per province in 2011

Province Harvested area (Ha) Production (MT) Yield (Ton/Ha)

North Sumatera 757.194 3.611.244 4,77

South Sumatera 772.803 3.332.799 4,31

Subtotal Sumatera 3.418.891 15.654.258 4,58

West Java 1.959.686 11.467.516 5,85

Central Java 1.748.611 9.429.506 5,39

East Java 1.945.712 10.533.607 5,41

Subtotal Java 6.192.549 34.148.340 5,51

West Nusa Tenggara 416.079 2.056.879 4,94

Subtotal Bali & Nusa Tenggara

757.866 3.473.210 4,58

West Kalimantan 441.920 1.379.411 3,12

South Kalimantan 490.528 2.001.274 4,08

Subtotal Kalimantan 1.289.917 4.557.268 3,53

Central Sulawesi 216.174 1.023.720 4,74

South Sulawesi 907.555 4.514.849 4,97

Subtotal Sulawesi 1.491.480 7.267.672 4,87

Other provinces/islands 73.676 284.435 3,86

Total Indonesia 13.224.379 65.385.183 4,94

Source: BPS 2012

In Indonesia with sun shines all year around, farmers can grow paddy three times a year. First crop season lasting from October to March, second crop from April to August and third crop from August to December. The first crop produces the main harvest. It produces about 60-65% of total national rice production in a year. The second crop produces about 25-30% and the third crop produces about 5-15% of total national rice production (Ellis 1993 in Sari 2010). Farmers manage their paddy cropping pattern adjusted with the availability of water. Paddy which is planted in Indonesia is wet type; it needs a lot of water for growing. Therefore mostly all farmers growing their paddy in rainy season (October-March). Whereas in the dry season not all farmers growing paddy, some of them growing

vegetables, corn, sweet potatoes, and legumes which do not need a lot of water for growing.

First crop Second crop Third crop

Month 10 11 12 1 2 3 4 5 6 7 8 9

Planting Mid-season Harvest

Figure 4 Seasonal Paddy Crop Calendar

Source: Ministry of Agriculture, Indonesia 2012 in FAS USDA 2012 The seasonal cropping pattern implies that the rice supply is not constant along the year. The excess supply occurs in the peak of harvest time at the first crop in February and March. While in the second and third crop, the rice supply cannot meet the rice demand in the market completely. In addition, the rice demand of Indonesian market is inelastic or constant along the year. The consequences of these conditions are the low price in the peak of harvest time and the high price in the time of lack supply. These conditions are not good either for consumer and producer. The low price in the peak of harvest time will hit farmers and the high price in the lack of supply will burden consumers. The mentioned conditions trigger high inflation and influence the macroeconomic condition. Since new technology has not been found to address this condition, government of Indonesia has been setting many policies to address these problems.

2.2 Rice Policies in Indonesia

Rice policies in Indonesia are comprehensive since it has been the most important commodity for Indonesia economically, socially, and politically. The Indonesian rice policies are divided into two types, anticipation policy and market intervention policy. Other than that the Indonesian rice policies can be divided into three phases based on the regime period of market policies. Sari (2010) explained the characteristics of each period as follow:

First phase is in 1967-1996 period, when the rice price was fully controlled by government through market interventions in purpose to enhance and maintain price stability. The full control power was given to Bulog as the only organization who organize the rice trade in Indonesia. The Bulog rights including monopoly right to control over international trade of rice, unlimited access to credit facilities from Bank of Indonesia, right to impose floor price and ceiling price as guarantee price for producer and consumer, right to procure the excess supply of rice from farmer as much as necessary to lift the rice price in harvest time until the determined floor price, the facilities of extensive logistical warehouses for rice stocks, and right to sell the stocks by mean of ceiling price. In this condition, price stabilization policy had succeed to dampen price volatility, stimulated the enhancement of rice production, and achieved rice self sufficiency in 1984. But the implementation of these policies paid high cost.

The second phase is in 1997-2000 period, when rice market of Indonesia was fully liberalized. In this period, all Bulog’s rights were omitted, import tariff was eliminated into 0% and all forms of the farm subsidies were repealed. These are the implication of the Letter of Intent (LOI) between the government of Indonesia, World Bank and International Monetary Fund (IMF) as the offered solution to overcome the financial crisis in 1998. With zero import tariffs, the Indonesian rice market was dominated by imported rice almost 6 MT from Thailand, Vietnam, and USA. Therefore the food self sufficiency was dropped in this period. There was no incentive for farmer to growing paddy. This condition was exacerbated by El Nino effect. In this period the rice prices in farmer market and consumer market were not stable. Inflation in this period was about 77,63%, it brings on -13,13% of economic growth for Indonesia.

After severe crisis in 1998, Indonesian economy moved on gradually. Since 2001 until now 2012, the government of Indonesia has been controlling the domestic rice market again with modified rules. The Indonesian rice market system is not tough enough for free trade, especially for the small farmers who have weak bargaining power and high dependency to rice production. The new national rice policies consists of five elements, they are rice production

enhancement, food diversification, price policies, import policies, and rice distribution for the poor (www.bulog.co.id).

Bulog transformed to be a state enterprise with public company status. Bulog has mandates to maintain price stabilization in the rice market through (www.bulog.co.id):

1) Domestic Procurement.

Bulog has right to procure the excess supply of rice in the harvest time from domestic market with determined Government Purchasing Prices (Harga

Pembelian Pemerintah/HPP) and determined characteristics. The previous

policy of floor price as the guarantee price for producer in the New Order is replaced by the Government Purchasing Price as a reference price for producer price. Bulog is given budget to procure about 7-8% of the total production (Natawidjaja 2011). Bulog purchases the excess supply by create a new demand in the market. Bulog only purchases the products which meet the requirement of HPP, so Bulog does not absorb the whole excess supply and does not guarantee the rice price for producers.

2) Manage Government Rice Reserve (Stock).

Bulog manage Government Rice Reserve as an anticipation way for food shortage problems, emergency in the case of disaster or food insecurity, and as a tool for rice price stabilization. Bulog gets the stock from domestic procurement and release it by the Market Operation and the Rice for the Poor Program. Every year Bulog has to provide stocks depends on the previous stock and the forecasting supply and demand. Ideally, Bulog has to have 0,75-1,25 MT in stock each year. These policies succeed to maintain stable rice supply in the domestic rice market when the world rice crisis occurred in 2007/2008.

3) Rice Distribution through Market Operation (Operasi Pasar/OP) and Rice for the Poor (RASKIN).

Bulog distributes its rice stocks to cover the shortage of rice supply and dampen the high price of rice in the market. Market Operation will be held if rice price rises in one week about 10% or more of the normal price compared to the normal price in three months before (Regulation of the

Minister of Trade no.04/M-DAG/PER/1/2012). The rice price is determined on the open market depends on supply and demand, but the Government through Bulog intervenes by inject rice supply into the rice market with Market Operation (Alexander & Wyeth 1995). In addition, Bulog has mandate to distribute rice for the poor (Raskin) with lower price directly to the targeted household. Bulog distributed 15 kg of rice/month for each poor family by IDR 1.600/kg.

4) Rice Import Policies.

Beside maintain domestic supply, Government also regulate the rice import mechanism. The rice import regulation is ruled by Decree of the Minister of Industry and Trade No. 9 Year 2004. This regulates that the rice import is banned in one month before main harvest, at main harvest, and two months after main harvest. The harvest time is determined by the Minister of Agriculture each year due to uncertain harvest time related to climate anomalies. The right to import rice is given to Bulog with tariff import at IDR 550/kg and import quota at 1,5 MT.

2.3 Indonesian Rice Market Chain

The rice market chain is the flow of rice from farmer in the production point to consumer in the retail market. Natawidjaja (2011) described the rice market chain in Indonesia consists of several marketing channels and marketing agencies. Most of the farmers sell their product to local collector, but some of them sell directly to large rice miller and small rice miller. The local collector is the middleman between farmer and large rice miller. In this part, farmers have weak bargaining power over buyers in the harvest time, because supply is redundant whilst the number of traders are less than farmers. Often price is determined by the trader.

Further, the paddy harvests are processed to be rice by rice milling unit. The rice millers distribute rice dominantly to the traditional central markets in the big cities or the capital of provinces. The rice supply to traditional central market is about 55% of rice miller’s product. The rest is distributed to Supermarket by 1γ%, Bulog by 7% and rice wholesaler trader by 25%. These marketing agencies take

role as wholesaler in the rice market chain. They buy rice in the big amount and do not sell their product directly to the consumer, except supermarket which produce home brand product. The traditional central markets in provinces sell their product to the traditional retail market then to the consumer. Whereas the rice wholesale trader sell their product to the rice agent at consumer area or directly to the retailer kiosk. Further the retailer kiosks sell their product directly to the consumer (Natawidjaja 2011).

Bulog which has stocks from the excess supply will store the stocks until necessary time. Bulog will release the stock through market operation both in the wholesale market and in the retail market when rice supply is shortage for consumers. The injection of Bulog is aimed to balance the market demand and to dampen the high price for consumers.

Figure 5 Rice market chain in Indonesia Source: Natawidjaya 2011

25% 55% 13% 7%

Farmer _Consumer

Traditional The retail market Traditional Central Market Large Rice Miller Local Collector Supermarket Bulog Rice Wholesaler Trader Small Rice Miller

Rice Agent at Consumer Area

Retailer Kiosk

2.4 Previous Studies on Rice Price Transmission in Indonesia

There are several studies about rice price transmission in the Indonesian market. These studies can illustrate how price transmissions had worked in the rice market of Indonesia, with variety of cases and conditions. The rice price performs in vertical and spatial markets from domestic market, national market and international market. The price transmission performances of Indonesian market also will be different depends on the time period of regime related to different policies.

In the international market case, Aryani (2009) found that the Indonesian rice market is integrated with Thailand and the Philippine with very weak level of cointegration. This condition might be caused by the persistence of import control policies (both tariff and non tariff) which are applied by these countries for rice trade. In the other study, the Indonesian central market (Jakarta) is cointegrated with international market (Bangkok) and domestic markets in Indonesia (Irawan 2006). The domestic markets are counted from the average rice price of 33 provinces in Indonesia. The study shows that if the international rice price increases by 1%, it will increase the domestic rice price by 0,4%. Whereas if the central market price in Jakarta increases by 1%, the domestic rice price will increase by 0,66%. The contrast result from Conforti (2004), he used annual price series and found that Indonesian rice market and international rice market are not cointegrated. But with the causality test, his study found that Bulog which holding monopoly power and managing domestic policies, following the world market price trends.

In the national market case for spatial market integration, the price transmissions among retail markets are not fully cointegrated. There are only 10 cointegrating vector from 12 retail markets in Indonesia, with Jakarta as a referred market. The wholesale markets are also not fully cointegrated. There are cointegrating vectors among Jakarta, Medan, and Makasar, but no cointegration between Makassar and Surabaya (Sari 2010).

The previous study from Istiqomah (2006) supports this results that the domestic markets in Indonesia are not fully integrated. In her study, she did ex-post study of liberalization policy implementation in Indonesia in 1998. The result

shows both regimes before and after liberalization is not fully cointegrated. The number of cointegrating vectors after market liberalization is less than before. There are about 22 cointegrating vectors of 26 domestic markets before market liberalization, and then decreased into 12 cointegrating vectors of 24 domestic markets after market liberalization. It means that the market liberalization made Indonesian market more segmented, whereas the purpose of the market liberalization is to build market to be integrated. She stated it may due to the delayed response of market, the high transaction costs of storage and distribution, non competitive market structure, the shortage of credit facilities, the slow information flows, and the weakness of human capital. Alexander and Wyeth (1994) studied the cointegration relationship among 27 provincial capitals of Indonesia and CPI. They found that the CPI is cointegrated with all rice prices series but without significant causality from it to rice prices.

Furthermore in the national vertical market, paddy price is cointegrated with rice price with different pace of adjustment (Sari 2010). Rice price in the retail market is more responsive when paddy price increases. When the rice price increases in the retail market, paddy price is less responsive. It shows that there is asymmetric price transmission in the vertical market of Indonesian rice market. In the domestic case, Irawan and Rosmayanti (2006) analyzed the vertical and spatial market integration in Bengkulu Province. Their study shows that the vertical market integration between consumer and producer in Bengkulu is not formed. Whereas the spatial market integration among the retail markets in Bengkulu are formed.

The rice price volatility information is also useful to support the analysis. The price volatility in the producer level is higher than the price volatilities in the wholesaler and consumer market (Sari 2010). The rice price volatility in 1977-1997 is about 17-21% (Mears 1982; Pranolo 2001 in Rusastra et al. 2004). Istiqomah (2006) found that the volatilities of paddy price and rice price were affected by liberalization policy in 1998. After liberalization rice price in farmer level was less volatile, whereas the rice price in consumer market was more volatile.

The liberalization policy high related with the existence of Bulog as the state enterprise which hold the price stabilization right. Bulog’s policies considered to be too partial to consumers and sellers than producers or farmers, thus the volatilities of paddy price in farmer level is more volatile than rice price volatilities in the consumer and wholesaler level (Sari 2010).

III THEORETICAL BACKGROUND

3.1 Price Volatility and Price Stabilization Policy

Price volatility explains the variance of data compared to their mean. The price volatilities of food commodity are really important, especially for rice which facing inelastic demand in the market. Price volatility will influence economic and welfare of the society (Bustaman 2003). When rice prices increase, the composition of public expenditure on rice will increase. These impacts are the reduction of revenue allocation for the other needs such as education and health. If the rice prices increase continuously and volatile, the more onerous burden for society which can reduce the welfare of society including farmers as the net consumer of rice.

In the Indonesian market, the standard of food volatilities determined by Government Regulation about Food Security No. 68 Year 2002 and Regulation of the Minister of Trade No. 22/M-DAG/PER/10/2005. These explain that high price volatility or unstable price for staple food is when the increases of rice price higher than 25% of normal price in a week.

Price stabilization on food can enhance economic growth and food security (Timmer 1996; Timmer 2004; and Dawe 2011). The advantages of price stabilization are that it can reduce the level of risk faced by producer and stimulates farmers to invest more to produce rice and raise productivity, meanwhile for consumer can get benefit from stable price and can alleviate poverty. These notions assumed that rice price transmitted completely from consumer to producer.

The price stabilization mechanism and its consequences are explained by simple Marshalian theory from Waugh-Oi-Massell in Newbery and Stiglitz (1981) (Istiqomah 2006). This theory assumes that the supply and demand are linear in the market and will response instantaneously when there is change of supply or demand, and additive stochastic disturbances. The changes of price equilibrium in the market due to supply or demand changes in the short-run will cause price volatility. The price stabilization is aimed to dampen the unstable prices and lead

the prices to the mean of its prices. The mechanism of price stabilization from Marshalian Theory is depicted as follow:

Figure 6 The Conventional analysis of supply-induced price variability Source: Newbery and Stiglitz 1981, page 17 in Istiqomah 2006

The figure above depicts for the decreased supply in the market. The decreased supply can be caused by bad weather, crop failure, drought, lean season, etc. With assumption of constant demand, when supply into market decreases, equilibrium price will rise (supply shifts from S1 to S2 , price follows to shift from P1 to P2 ). The price stabilization attempts to stabilize price at its mean, P, without change in average supply. The impact of price stabilization can be explained by the changes of consumer surplus and producer surplus.

The government of Indonesia has imposed price stabilization through i) determine floor price or ceiling price in the market and ii) inject additional supply or demand into market with determined government purchasing price. The first policy is used by the government of Indonesia in the New Order period in 1967-1998, whereas the second policy is imposed in the new regime after reformation period since 2005 until now (Kusumaningrum 2008). The mechanisms of price stabilization of these methods are depicted bellow:

P P2

0 Q2 Q Q1

P1

Price

Quantity D

S2

.

Figure 7 The enforcement of floor price to stabilize price in the market Source: Kusumaningrum 2008

Figure 7 explains that when supply increases from S1 to S2, then the price decreases from P1 to P2, the government imposes the floor price as the minimum price which is allowed. The consequence of this policy is that the government has to purchase rice as much as the excess supply/surplus (QS*-QD*) with the determined floor price in the market. In this case, government guarantee that the price in the market will not being lower than the floor price.

Figure 8 The enforcement of government purchasing price to stabilize price in the market

Source: Kusumaningrum 2008

Dgovernment + consumer

Q3

Dconsumer

Qgov P3*

P1

0 Q1 Q2

P2 Price

Quantity S1

S2 surplus

QD*

Qgov

Floor price P1

0 Q1 Q2

P2 Price

Quantity Dconsumer S1

S2

Figure 8 explains how the government purchasing price by Bulog works to stabilize price in the market. The government effort to stabilize price through inject additional demand into market with determined price, determined characteristics and depends on the capability of Bulog to purchase for stocks. Government has had a percentage of purchase equal to 8 percent of all the existing supply in the main harvest time. With the proportion of 8 percent, the government easier in budgeting, planning, and budget calculation. There is no guarantee for price in the market for the case of government purchasing price. The rice price equilibrium depends on the supply and demand in the market. The government purchasing price takes a role just as referenced price for market.

3.2 Price Transmission and Market Integration

Price transmission and market integration topic has been growing to be the important issue in agricultural market policy. This issue becomes one of considerations for decision making process in agricultural market policy due to its advantages to give insight about the effect of its implementation for the economic welfare. Price transmission parameter useful to indicate the direction, the magnitude and the distribution of benefit and the cost of trade policy implementation (Rapsomanikis et al. 2006)

There is no formal definition about price transmission. But there are some concepts required to determine the price transmission and market integration. The price transmission reflects the extent of market integration. Fackler and Goodwin (2001) defined two markets are integrated if shock in one market is transmitted to the other market. Specifically for illustration, goods X in market A is integrated with market B if shock in the market A for example the demand changes will influence the goods X price both in market A and market B. This indicates that goods X has long-run cointegration among market A and market B.

Barrett (2001) said that price transmission or market integration as the satisfaction of the Law of One Price (LOP). The LOP states that if trade occurs between two markets and all profitable arbitrage opportunities are eliminated, the prices of two markets are equalized up to the cost of commerce (Barrett 2001).

The LOP is supposed to regulate for spatial market integration, whereas for vertical market integration depends on production costs (Conforti 2004)

In addition, a basic concept, which is always used in spatial market integration analysis, is the Enke-Samuelson-Takayama-Judge model. This model postulates that price transmission is occurred when changes of price of one commodity in one market (P1t) transmitted to the price in other market (P2t) with reflected price plus transfer cost (C). Transfer cost in the spatial market context for example is transport cost, whereas in the vertical market is marketing margin (Brümmer et al. 2009). This postulate follows the Law of One Price postulate (LOP). The relationship between the prices is as follows:

P1t = P2t + C ... ... (1)

There are three notions of price transmission concept, they are co-movement and completeness of adjustment, dynamic and speed of adjustment, and symmetry or asymmetry response adjustment (Rapsomanikis et al. 2006). Price transmission analysis can be used to check the degree of market efficiency, in terms both of them close to the competitive model (Barrett & Li 2002).

The degree of price transmission depends on some factors, these factors can disrupt or even omit the price transmission. They are transaction costs, transportation cost, market power, increasing return to scale in production, product homogeneity and differentiation, exchanges rates, border and domestic policies, market imperfection (Conforti 2004; Keats et al. 2010), market structure (Braun 2008), trade policies, marketing margin, and communication infrastructure (Rapsomanikis et al. 2006). The government policies can impede the price transmission through agricultural policy instrument such as import tariffs, tariff rate quota, export subsidies or taxes, and interventions mechanism. But government policies not always hinder price transmission and market integration, it depends on the nature of the policy instruments employed (Rapsomanikis et al. 2006).

Price transmission in the market chain is included into vertical price transmission. Vavra and Goodwin (2005) define vertical price transmission as

“the adjustment to price shocks along the chain from producer to wholesaler and to retail levels, and vice versa.” Price transmission analysis which involved the intermediate in the market chain can show how the successive price transmission of shock from the point of origin until the end of market chain. Imperfect pass-through among intermediate can impede the price transmission and the transferred benefit from consumer to producer, and vice versa. Vertical price transmission has important role to determine the effects of trade policy in the size and the distribution of welfare (Vavra & Goodwin 2005).

There is one characteristic of vertical price transmission which is often found in the market chain of food commodity, this is asymmetric price transmission. It emphasizes the different pace responses from price reduction and price increase (Vavra & Goodwin 2005). The price reduction of food commodity in farm is transferred through the market chain slowly and possibly not fully until consumer. Whilst, the price increase at farm level is transmitted quickly through market chain until consumer. The possibility causes of asymmetry price transmission are the present of many small intermediaries (Peltzman 2000), market concentration and market power (McCorriston & Sheldon 1996).

3.3 Operational Framework

The background of this study is the resilience of the Indonesian rice market faced the world rice price crisis in 2007/2008 and in 2010/2011. Beside the effect of good harvest in 2007, the stable price also comes from the enforcement of comprehensive policies by the government of Indonesia to maintain stable price in the consumer market. The phenomena raise a question how about the rice market chain performance in this period? The good condition in the consumer market should be transferred to the production market, so producers in the production point get the same benefit like consumers (the transferred benefit).

This study analyzes the relationships between producer price-rice miller price, producer price-wholesaler price, producer price-retailer price, rice miller wholesaler price, rice miller retailer price, and wholesaler price-retailer price. We analyze the market chain performance through price volatility analysis and price transmission analysis. Price volatility analysis uses standard

deviation of return and price transmission analysis uses Error Correction Model. From this study we supposed to get the insight about the market integration along Indonesian rice market chain, whether this is integrated or not. Then we analyze the possible related causes and analyze the effects of the government interventions into the price transmission performance. We can recommend the policy implication from this study relate to the rice policy and the price transmission in Indonesian rice market chain.

Figure 9 Operational framework of this study rice prices

crisis in the world market

2007/08 and 2010/11

Stable rice prices in Indonesian market

Good harvest in 2007

Market interventions Indonesian rice market

chain performance? (vertical market)

producer rice miller wholesaler retailer

Price volatility analysis

Price transmission analysis

Policy Implication Standard deviation

of return

Error Correction Model

IV METHODS

4.1 Data and Collecting Method

The study uses national average monthly data of rice prices in producer level, rice miller level, wholesaler level and retailer level from January 2000 until May 2012. These data are secondary data, which are collected from relevant institutions in Indonesia. They are Bulog (Logistic Department of Indonesia), Statistics Central Board of Indonesia (BPS), Directorate General of Processing and Marketing of Agricultural Products in the Ministry of Agriculture, and PT Food Station Tjipinang Jaya.

4.2 Data Processing and Analysis Method

This study analyzes the price volatility by determine the standard deviation of return of each level in the market chain and the price transmission analysis by Error Correction Model. The steps on this analysis are Unit Root Test, Cointegration Test, and estimation of Error Correction Model. The processing data will use excel and Jmulti software.

4.2.1 Volatility Analysis

The price volatility shows how much the price dispersion (price volatility) from their mean (Kotze 2005). This study uses the standard deviation of return to find out the price volatility of time series data. If the price volatility is bigger, it can be concluded that the price series have a tendency to fluctuating with the mean. The equation to estimate the standard deviation of return is:

u1 = ln (Pt) – ln (Pt-1) = ln (Pt/Pt-1) ... (2) Note:

u1 = the standard deviation of return; Pt = current price; Pt-1 = past price

This study analyze the price volatilities of four market institutions in the market chain, they are producer price, rice miller price, wholesaler price, and retailer price. We compare the price volatilities among them and see if the

volatilities show the impact of market interventions. In addition we will compare the volatilities of rice price between before crisis period in 2000-2006 and during crisis period in 2007-2011. We use F-test to test the significance of difference between before and after crisis. The hypotheses are:

H0: σ12 ≤ σ22 (the variances before crisis and during crisis are similar) H1: σ12 > σ22 (the variance before crisis is higher than during crisis) We compare the F-value to the F-table; we reject Hypothesis null if F- value is bigger than F-table. We get the F-value from the simple formula, F-value = s12/s22. The results of this comparison will show us whether there is any differences of price volatility between before crisis period and during crisis period. The critical value for F-table (95%, 85,64) is 1,4824. Note: df 85 is the number of series before crisis (N1 = 85) and df 64 is the number of series after crisis (N2 = 64).

4.2.2 Price Transmission Analysis

The analysis of price transmission starts by investigating the stationary of series data by unit root test, then continue to the cointegration test and the Error Correction Model (ECM) analysis.

a. Testing for Unit Roots

First step to process price transmission analysis is that we have to examine the stationary of the data series through unit roots test. The stationary of each series data is needed to prevent the spurious regression in the model. We want to confirm whether the series data are stationary in the same order or not. The data will be valid to use if the variables in the model are in the same order.

Xt = Xt-1 + ɛt ... (3) With hypothesis H0: =1 and H1: <1, but since has non standard distribution, we cannot use the standard t-test. Then the model developed to be the Augmented

Dickey Fuller. The unit root test can be analyzed by using Augmented Dickey Fuller test (ADF). The specification of Augmented Dickey Fuller model is:

Xt– Xt-1 = Xt-1 – Xt-1 + ɛt ... (4) Δ Xt= ( -1) Xt-1 + ɛt ... (5) Δ Xt = ( -1) Xt-1 + ∑ ΔXt-j + ɛt ... (6) The hypotheses of this test are:

H0: = 1 (data has a unit root or data is not stationary) H1: ≠ 1 (data does not have a unit root or data is stationary)

The test criterion is: we reject Ho if t-value is bigger than t-table. The critical values for 10% = -1,62; 5% = -1,94; and 1% = -2,56. In this study we assess the stationary of producer price, rice miller price, wholesaler price, and retailer price in the level I(0) and in the differenced form I(1) . We also assess the stationary of the errors from the models of producer price-rice miller price, producer wholesaler price, producer retailer price, rice miller price-wholesaler price, rice miller price-retailer price, and price-wholesaler price-retailer price. We also want to confirm that the relationships among them are valid and cointegrated.

b. Determination of the Optimum Lag

Determination of the optimal lag for the regressed variable in the equation is purposed to avoid the possibility of residual autocorrelation in the series of rice price. We use Schwarz Bayes Criterion to choose the appropriate lag length. Schwarz Bayesian Criterion has shorter lag length than Akaike Information Criterion, which frequently used. We supposed Schwarz Bayesian Criterion is more appropriate for this study; due to the rice production cycle in Indonesia is three times a year. So we supposed the dynamics short-run of price transmission are happened within no more than 4 months.

c. Cointegration test

Cointegration test between two series data analyzed the tendency toward one common behavior in the long run, even in the short-run they behave in the different way. The aim of cointegration test is to analyze the existence of cointegrating vector in the model. We can test the cointegration through verify the order of variables and its error and the Johansen Trace test. In the first test we have to verify whether Px and Py are stationary in the same order and the error stationary in the level from Py = α + Px + ɛt. If these are confirmed, it means that Px and Py are cointegrated. This study also uses Johansen Trace Test to determine the existence of cointegrating vector in the model. There are two hypothesis tested here:

1) Rank test 0

H0: There is no cointegrating vector H1: There is one cointegrating vector 2) Rank test 1

H0: There is one cointegrating vector H1: There are two cointegrating vectors

We reject H0 if eigenvalue (LR) is bigger than the level of significant or P-value less than critical P-value (α). We test the existence of cointegrating vector in the models of: producer price-rice miller price, producer price-wholesaler price, producer retailer price, rice miller wholesaler price, rice miller price-retailer price, and wholesaler price-price-retailer price.

.

d. Error Correction Models

The characteristics of the dynamic relationship can be explained by Error Correction Model (ECM). This study uses the Johansen Maximum Likelihood Error Correction Model to estimate the dynamics in the short-run, the dynamics in the long-run equilibrium, and koefficient of the ECM simultaneously by one step. The specification of Error Correction Model is:

ΔPXt = a + ∑ iΔPX t-i + ∑ iΔPYt-i + α1 [PX t-1 - θ1PY t-i + c] ... (7)

Note:

A = the dynamics short-run B = the error correction parameter C = the long-run equilibrium

The Error Correction Model explains the short-run adjustment of prices toward the long-run equilibrium (Conforti 2004). The long-run equilibrium indicates as a measure of the degree of price transmission of one price to the other, whilst the short-run adjustment indicates the speed of price transmission contemporaneously (Prakash 1999 in Conforti 2004).

The specifications of Error Correction Models in this study are: 1) Producer Price-Rice miller Price

ΔMPt= 11ΔMP t-i + 12ΔPPt-i+ α1 [MP t-1 - θ1PP t-i + c] ... (8) ΔPPt= 21ΔMP t-i + 22ΔPPt-i+ α2 [MP t-i - θ1PP t-i + c] ... (9) 2) Producer Price-Wholesaler Price

ΔWPt= 31ΔWP t-i + 32ΔPPt-i+ α3 [WP t-i - θ2PP t-i + c] ... (10) ΔPPt= 41ΔWP t-i + 42ΔPPt-i+ α4 [WP t-i - θ2PP t-i + c] ... (11) 3) Producer Price –Retailer Price

ΔRPt = 51ΔRP t-i + 52ΔPPt-i + α5 [RP t-i - θ3PP t-i + c] ... (12) ΔPPt = 61ΔRP t-i + 62ΔPPt-i + α6 [RP t-i - θ3PP t-i + c] ... (13) 4) Rice miller Price –Wholesaler Price

ΔWPt = 71ΔWP t-i + 72ΔMPt-i + α7 [WP t-i - θ4MP t-i + c] ... (14) ΔMPt = 81ΔWP t-i + 82ΔMPt-i + α8 [WP t-i - θ4MP t-i + c] ... (15) 5) Rice miller Price –Retailer Price

ΔRPt = 91ΔRP t-i + 92ΔMPt-i + α9 [RP t-i - θ5MP t-i + c] ... (16) ΔMPt = 101ΔRP t-i + 102ΔMPt-i + α10 [RP t-i - θ5MP t-i + c] ... (17) 6) Wholesaler Price –Retailer Price

ΔRPt = 111ΔRP t-i + 112ΔWPt-i + α11 [RP t-i - θ6WP t-i + c] ... (18) ΔWPt = 121ΔRP t-i + 122ΔWPt-i + α12 [RP t-i - θ6WP t-i + c] ... (19)

Note:

PP = Producer price (IDR/kg) MP = Rice miller price (IDR/kg) WP = Wholesaler price (IDR/kg) RP = Retailer price (IDR/kg)

α = the coefficient of Error Correction Model = the coefficient of dynamic short-run θ = the slope of long-run equilibrium

V RESULTS AND DISCUSSION

5.1 Rice Price Volatilities

The price volatilities in each market institutions are shown by standard deviation of return in the Table 3. Producer price has the highest price volatility by 24,90%. Whilst, rice miller price and wholesaler price have lower volatilities than producer price by 18,30% and 18,10%, respectively. The retailer price has the lowest volatility by 8,7%. This result shows that the magnitudes of the price volatility from producer to consumer are decreasing. Farmers in production market face very high volatility of producer price, meanwhile consumers receive stable price. This unbalance condition is not good for farmers and the market efficiency.

Table 3 The price volatilities of producer, rice miller, wholesaler, and retailer

Variable PP MP WP RP Period SD (%) SD (%) SD (%) SD (%)

2000-2012 0,249 - 0,183 - 0,181 - 0,087 -

2000-2006 0,279 - 0,165 - 0,188 - 0,089 -

2007-2012 0,207 25,96* 0,205 24,19 0,173 -8,34 0,084 -5,43 Note: Asterisk sign indicates reject Ho: there is no difference between two variances (Ho: σ21 ≤ σ22), at 95% level of significant

The high volatility of producer price is reasonable due to the price gap of seasonal prices. The rice price at producer level in the harvest time is low because the abundant of rice supply in the market. On the contrary, the rice price is high in non-harvest time when the supply is shortage. The gap production is too big between main harvest in February-March which produces 60-65% of total production and the other two harvest time which produce 25-30% and 5-15% of total production. The capacity of Bulog, which only can purchase 7-8% of total production cannot balance rice price for along the year. The government instrument to purchase the excess of supply in harvest time cannot dampen the

volatility of seasonal rice price completely. This is the source of rice price volatility problem.

The volatilities of rice miller price and wholesaler price are lower than the volatility of producer price. Since rice miller and wholesaler have ability to hold the stock for short time and wait for the better price to release it. They also get the advantages from access to the market information. Whereas the retailer has the smallest price volatility at 8,70%. It means that consumers face relatively stable rice price along the year. The rice price stabilization policy through market operation is successful to provide stable price for people along the year.

This study also compares the rice price volatilities between before crisis period in 2000-2006 and during crisis period in 2007-2012. We test the significance of differences in variances using F-test. We want to confirm the expectation that the price volatility during crisis period is less than before due to the government intervention to control the price in this period (H1: σ12> σ22). The result shows only producer price which significantly has price volatility less than before crisis (see Appendix 1). The decrease of producer price volatility is supported by the good production in this time and it is related to the enforcement of government purchasing price from 2007 until now. Meanwhile, the volatility changes of rice miller price, wholesaler price and the retailer price are not significantly different. This confirms that there are no shocks of rice prices in the crisis period in Indonesian market in 2007-2012. The rice prices are relatively stable like before crisis for rice miller, wholesaler, and retailer.

5.2 Rice Price Transmission and Market Integration 5.2.1 Unit Root Test

The first step to examine the market integration is that we have to confirm that the data series are stationary to avoid the spurious regression in the models. The Table 4 shows the result of Unit Root test to test the stationary of variables. On the level for all variables, there are insufficient evidences to reject the null hypothesis of non-stationary. Whereas at the first differenced series, there are strong evidences to reject the null hypothesis of non-stationary. This indicates that all price series are I(1).

Table 4 Unit Root test result

Variables t-statistic Error of Model t-statistic

Producer Producer-Rice miller

Level (2) 2.1271 u1 in level (0) -6.9459***

Differences (1) -11.7015*** Producer-Wholesaler

Rice miller u2 in level (0) -4.2549***

Level (10) 5.8841 Producer-Retailer

Differences (1) -12.2466*** u3 in level (2) -2.9671***

Wholesaler Rice miller-Wholesaler

Level (0) 1.7797 u4 in level (0) -3.8677***

Differences (0) -10.1124*** Rice miller-Retailer

Retailer u5 in level (2) -2.4995**

Level (2) 4.6505 Wholesaler-Retailer

Differences (1) -7.7232*** u6 in level (0) -3.8611*** Note: the number in parentheses indicates the lag length. One (*), two (**), and three (***) asterisks indicate rejection of unit root at 10%, 5%, and 1% level of significance, respectively. Critical values for 10% = -1,62; 5% = -1,94; and 1% = -2,56. Reference: Davidson, R. and MacKinnon, J. (1993),"Estimation and Inference in Econometrics" p 708, table 20.1, Oxford University Press, London

Beside the stationary test for series price data, we have to confirm the stationary of the errors in the pair wise models. They are the errors of Producer-Rice miller, Producer-Wholesaler, Producer-Retailer, Producer-Rice miller-Wholesaler, Rice miller-Retailer, and Wholesaler-Retailer. Table 4 shows there are strong evidences to reject the null hypothesis of non stationary for the errors on level for all models. It means all errors are I(0). Therefore, we conclude that all variable are stationary and valid to use. This also means that each pair wise models are cointegrated.

5.2.2 Cointegration and Error Correction Models 1) Producer Price-Rice Miller Price

First relationship is between producer price and rice miller price. Table 5 shows that there are strong evidences that producer price and rice miller price are cointegrated. The Johansen Trace test rejects the null hypothesis of no cointegration, but fails to reject the null hypothesis of one cointegrating vector. The cointegration indicates that producer price and rice miller price are integrated.

Table 5 Cointegration test for producer price-rice miller price (3 lags)

Johansen Trace Test Level of significant

r0 LR P-value 90% 95% 99%

0 29,71 0,0014 17,98 20,16 24,69

1 6,36 0,1704 7,60 9,14 12,53

After we know that there is one cointegrating vector between producer and rice miller, we continue to examine the extent of their relationship. The Error Correction Model result shows the short-run dynamics, the adjustment parameter, and the long-run equilibrium. In the short-run there are no significant differenced lag variables. It means in the short run producer price and rice miller price move in the different way. The error correction as the adjustment parameter shows that it adjusts very fast about 0,513 of the divergence from the long-run equilibrium being corrected each month. The long-run equilibrium will be achieved when producer price increase about IDR 1.000, rice miller price will increase about IDR 1.025.

The rice price from producer is transmitted to rice price in rice miller. The factors which may influence this relationship are product linkage, transaction costs, trade barrier, transparancy of information and market power. Producer price and rice miller price interact directly in the market, so there is strong linkage in the product flows. This product linkage strongly influences the price determination for both producer price and rice miller price. So, in the long-run they move together in the same way. Transaction costs including transportation cost to moving rice product from producer to rice miller is relatively low because

commonly producer and rice miller are in one region. Low transaction costs can strengthen the market signal of rice price in the market.

Table 6 Error Correction Model for producer price-rice miller price

Dependent variable ΔMPt ΔPPt

Independent variable parameter t-value parameter t-value

ECM t-1 0,051 0,198 0,513* 1,859

ΔMP t-1 0,368 1,277 0,446 1,453

ΔPP t-1 -0,044 -0,156 -0,150 -0,505

ΔMP t-2 -0,422 -1,550 -0,386 -1,333

ΔPP t-2 -0,062 -0,237 -0,083 -0,298

ΔMP t-3 -0,001 -0,006 0,002 0,010

ΔPP t-3 0,158 0,687 0,163 0,666

Long-run Equilibrium:

MPt-1 = 12,738 + 1,025 PPt-1***+ ut-1 (0,704) (-123,479)

Note: One (*), two (**), and three (***) asterisks indicate rejection Ho: = 0 at 10%, 5%, and 1% level of significance, respectively. Critical values for 10% = 1,645; 5% = 1,96; and 1% = 2,576.

In addition, there are no trade barrier policies between producer and rice miller. Even though there is domestic purchasing by Bulog with determined Government Purchasing Price, but Bulog only absorbs about 7-8% of the total production and cannot reduce the impact of seasonal price. The effect of seasonal price from producer price is too big to not be transmitted because they have strong linkage in product flow. Therefore, producer price will influence the price determination in the rice miller market.

If we compare with the volatility analysis result, the high volatility of seasonal producer price at 24,9% is transmitted to rice miller with lower price volatility at 18,3%. Nevertheless, rice miller can reduce its transferred seasonal volatility by manage the stock in short-run and the time to sell their product with better price.

2) Producer Price-Wholesaler Price

The second relationship is between producer price and wholesaler price. Table 7 shows that there are no sufficient evidences that producer price and wholesaler price are cointegrated. The Johansen Trace test cannot reject the null hypothesis of no cointegrating vector. It indicates that producer price and rice miller price are not integrated. Price determination of wholesaler price is not related with producer price, and vice versa. Each price is determined by its previous prices (autoregressive). They behave in the different way both in the short-run and the long-run.

Table 7 Cointegration test for producer price-wholesaler price (3 lags)

Johansen Trace Test Level of significant

r0 LR P-value 90% 95% 99%

0 16,95 0,1358 17,98 20,16 24,69

1 4,68 0,3317 7,60 9,14 12,53

The factors which may influence this relationship are transaction costs, market information, market power, and market operation policy. Transaction costs to deliver rice product from producer to wholesaler are high because the rice product has to pass the other marketing intitution, the rice miller. The rice miller cost potentially increases the transaction costs to deliver rice from producer to wholesaler. As we stated before, transaction costs potentially inhibit the price transmission. Transaction costs consist of processing cost, storage cost, transportation cost, and marketing margin between producer and wholesaler. The indirect interaction also influences the transfer of market information. Farmers as producer commonly do not have access about the demand and the price in wholesaler market. Therefore, there are no price adjustments between producer and wholesaler.

In addition, wholesaler can store the rice product in warehouse and manage its supply. If we compare the price volatilities of them, wholesaler price volatility (18,1%) is lower than producer prices volatility (24,9%). This ability became market power for wholesaler to control its price and to inhibit the high seasonal

Braun JV. 2008. Food and financial crises: implications for agriculture and the poor. Food Policy Report of International Food Policy Research Insstitute (IFPRI).

World Bank. 2008. Commodity markets review November 12. Washington DC: DECPG The World Bank.

Appendix 1 F-test for test the difference of variance of rice prices before and during crisis

Variable Standard

deviation (σ)

Variance

(σ2

)

F-value = s12/s22

F-table (95%, 85,64)

Producer price

Before 0,279 0,078 1,817*** 1,4824

After 0,207 0,043

Rice miller price

Before 0,165 0,027 0,648 1,4824

After 0,205 0,042

Wholesaler price

Before 0,188 0,035 1,181 1,4824

After 0,173 0,029

Retailer price

Before 0,089 0,008 1,122 1,4824

After 0,084 0,007

Appendix 3 Graph of producer price and wholesaler price in 2000-2012

Appendix 5 Graph of rice miller price and wholesaler price in 2000-2012