Report No. 10504-IND Indonesia: Agricultural Transformation Challenges and Opportunities (In Two Volumes) Volume l: The Main Report September 1, 1992 MICROFICHE COPY AgriculturalOperationsDivision Report No.:10504-IND Type: (SEC) Country Departmentll T iitle: AGRICULTURAL TRANSFORMATION East Asia and Pacific Regional Office Author: GANGULY, S. Ext.:82547 Room: 9 007 Dept.:EA3AG I N 2 VOLS . FOR OFFICIAL USE ONLY Document of the World Bank This document hasca restricted distribution and may be,used by recipients only 'n the perforit4ance of their official duties. Its contents may not otherwise be _disclosed without World Bank authorization. - ii - CURRENCY EQUIVALENTS Before November 15. 1978 US$1.00 - Rp 415 Annual Average 1985-91 1985 US$1.00 - Rp 1,111 1986 US$1.00 - Rp 1,283 /L 1987 US$1.00 - Rp 1,644 1988 US$1.00 - Rp 1,686 1989 US$1.00 - Rp 1,770 1990 US$1.00 - Rp 1,843 1991 US$1.00 - Rp 1,950 FISCAL YEAR Government - April 1 to March 31 Bank Indonesia - April 1 to March 31 State Banks - January 1 to December 31 /a On September 12, 1986 the Rupiah was devalued from US$1.00 - Rp 1,134 to US$1.00 - Rp 1,644. (There was also an earlier devaluation on March 30, 1983). FoR o0CAL UE ONLY - iii - ABBREVIATIONS. ACRONYMS AND INDONESIAN TERN9 AARD * Agency for Agricultural Resea.'ch and Developmzent AD8 - Asian Development Bank BASM - BAPPENAS Agricultural Sector Model BAPEKSTA - Duty-Drawback Scheme BAPPENAS - National Development Planning Agency BIMAS - Rice Intensification Pt 3gram BPS - Biro Pusat Statistik (Central Statistical Bureau) BPP - Bina Program Pengairan (Planning Bureau Irrigation) BRI - Bank Rakyat Indonesia BULOG - National Logistics Agency CASER - Center for Agro-Socio-Economic Researcl DO - Directorate General DGWRD - Directorate General of Water Resources Development EC - European Community ERP - Effective Rates of Protection FAO - Food and Agriculture Organization of the UN BY - High Yielding AInC - International Agricnltural Research Center ICRISAT - International Center for Research in Semi-Arid Tropics IIMI - International Irrigation Management Institute IITA - International Institute of Tropical Agriculture INPRES - Instruksi President (Grant by Presidential instructions) IPM - Integrated Pest Management IRRI - International Rice Research Institute ISF - Irrigation Service Fee ISNAR - International Service for National Agricultural Research IUD - Village Cooperative MOA - Ministry of Agriculture MSY - Maximum Sustainable Yields NeS - Nucleus Estate and Smallholders Program NTB - Non-Tariff Barriers NRP - Nominal Rate of Protection O&M - Operation and Maintenance OPEC - Organization of Pecro'eum Exporting Countries PTP - State-owned Limited Liability Estate Company or Public Estate Company Palavija - Non-rice, secondary food crops PIR-TRANS - A scheme for private nucleus estate and smallholder development for transmigrants PMU - Project Management Unit PPL - Field Extension Worker PPS - Subject Matter Specialists Repelita - Five-Year Development Plan RePPProt - Regional Physical Planning Program for Transmigration SUSENAS - Food Consumption Surveys TAHU - Molded Soybean Cake TEMPE - Soybean Curd TRI - Smallholder Intensification Program for Sugar Cane This document has a restricted distribution and may be used by recipients only in the performanco of their offcial duties. Its contents may not otherwise be disclosed without World Bank authorltion. - iv_ INDONESIA AGRICULTURAL TRANSFORMATION: CHALLENGES AND OPPORTUNITIES Table of Contents Page No. E-ecutive Summary . . . . . . . . . . . . . . . . . . . . . ix 1. HISTORICAL PERSPECTIVE ON AGRICULTURAL DkVELOPMENT - A SUCCESS STORY . . . . . . . . . . . . . . . . . 1 - Agriculture and the Contained Dutch Disease . . . . . 1 - Development Objectives Largely Achieved . . . . . . . 2 - Policy Instruments . . . . . . . . . . . . . . . . . 6 - Itapact--Primarily Rice on Java . . . . . . . . . . . 9 II. EVOLVING FOOD DEMAND PATTERNS - DIVERSIFICATION . . . . . . 15 - Trende in Food Consumption and Calorie Intake . . . . 15 - Comparisons with Other Countries . . . . . . . . . . . 17 - Determinants of Future Food Demand . . . . . . . . . 19 - Demand Towards Year 2010 . . . . . . a.. . . . . . . . 24 - Rice Demand - Comparative Analyses (various studies) . 26 III. C'ANGING SUPPLY PROSPECTS AND CHALLENGES - MULTIPLE SOURCES OF GROWTH ............ .... .. 29 - Land and Water Resources . . . . . . . .. . . . . 29 - Supply Prospects for Rice and Other Commodities . . . 39 - Summary of Supply Projections - Comparative Analyses (various studies) . . . . . . . . . . . . . . . . . 54 IV. EVOLVING PUBLIC INSTITUTIONS/SUPPORT SERVICES AND INCREASING ROLE OF PRIVATE SECTOR E C.........57 - Government Expenditures - Trends and Priorities . . . 57 - Research and Extension - Organization, Management and Priorities . . . . . . . .. . . . .... . . 73 - Enhancing the Role of the Private Sector . . . . . . 77 V. DEREGULATING PRICE AND TRADE REGIMES . . . . . . . . . . . 84 - Agricultural Import Licensing Regime in Transition . 86 - Export Licensing Regime in Transition . . . . 87 - Protection in Agricntlture Versus the Rest of tne Ecoromy . . . 9 9 . * 9. . 0 9 . . . 88 - Policy Trade-Offs--Specific Commodities . . . . . . . 90 VI. IMPLICATIONS FOR FUTURE DEVELOPMENT OF THE SECTOR AND THE ECONOMY .a. . . . .. . . .. * . .. . . .. . . . . . .. 107 - Growth in Agricultural GDP . . . . . . . . . . . . . 107 - Impact on Poverty Alleviation . . . . . . . . . . . . 111 - Impact on the Environment . . . . . . . . . . . . . . 115 - Future of Agriculture in Structural Transformation . 117 -v- Paste No. VII. AGENDAFOR THE FUTU.................. . 124 - Public Investment Priorities . . . . . . . . . . . . 124 - Actions on the Policy Front . . . . . . . . . . . . . 125 - Actions to Strengthen/Foster Institutions . e . o . . 126 - Areas Requiring External Donor Assistance . . . . . . 128 - Areas Requiring Further Work . . . . . . . . . . . . 128 TEXT TABLES 1.1 Comparative Performance of Indonesia and other Oil Exporting Countries . .. ........... ........ ...................... 2 1.2 Shares of GDP and Sectoral Growth Rates . . . . . . . . . . 3 1.3 Subsector Share of Agriculture GDP and Growth Rates . . . . 4 1.4 Employment by Main Industry . . . . . . . . . . . . . . . . 4 1.5 Implied Employment Elasticities for Indonesia . . . . . . . 5 1.6 Agricultural Exports . . . . . . . . . . . . . . . .. 7 1.7 Import of Agricultural Products. . . . . . . . . . . . . . 8 1.8 Regional Area and Population Statistics, Selected Years, 1971-1989 . . . . . . . . . . . . . . . . 10 1.9 Regional Distribution of Farm Size, 1983 . . . . . . . . . 10 1.10 Regional Impacts of Growth, 1979 - 1988 . . . . . . . . . 11 1.11 Sources of Growth in Paddy Production, 1969-89 . . . . . . 12 2.1 Per Capita Human Consumption of Major Foods . . . . . . . . 15 2.2 Calorie Intake by Najor Food Groups . . . . . . . . . . . . 16 2.3 Share of Food Expenditure by Processing Level . . . . . . . 17 2.4 Demographic Trends . . . . . . . . . . . . . . . . . . . . 21 2.5 Average Per Capita Expenditures in Urban and Rural Areas . 23 '.6 Demand Projections (Food and Feed) . . . . . . . . . . . . 24 2.7 Projected Per Capita Calorie Food Consumption . . . . . . . 26 2.8 Share of Major Food Groups in Total Calorie Intake in the Year 2010 . . . . . . . ... . . . . .. . . . .a 27 2.9 Comparison of Rice Demand Projections . . . . . . . . . . . 28 3.1 Land use in Indonesia (Average of 1984-90) . . . . . . . . 30 3.2 Arable Land by use on Java and Madura . . . . . . . . . . . 33 3.3 Potential Availability of Land for Wetland Development . . 34 3.4 Trends in Real Costs of Irrigation . . . . . . . . . . . . 35 3.5 Land Available for Rice Production 1988 and 2010 . . . . . 36 3.6 Irrigation Efficiency Levels (Z) . . . . . . . . . . . . . 37 3.7 Potential for Rice Production . . . . . . . . . . . . . . . 41 3.8 Summary of Paddy and Rice Production Potential . . . . . . 42 3.9 Corn Projections . . . . . . . . . . . . . . . * . 45 3.10 Soybean Projections . . . . . . . . . . . . . . . . . . . . 47 3.11 Fish Production and Sustainable Yields ('000 tons): 1988 . 52 - vi - TEXT TABLES (CONTP No. 3.12 Fish Production and Demand Projections . . . . . . . . . . 53 3.13 Growth Rates of Major Tree Crop Products . . . . . . . 54 3.14 Projections of Sup,ly of Agricultural Products . . . . . . 55 4.1 Public Expenditures on Agriculture: Indonesia vs. Selected Other Countries, 1984-88 Average . . . . . . . . 58 4.2 Indicators of Public ExDenditures on Agriculture . . . . . 58 4.3 Trends in Foreign Financing . o . . . . . . . . . . . a . . 60 4.4 Breakdown of Fertilizer Subsidy, 1991/92 . . . . . . . . . 63 4.5 Fertilizer Subsidy and Irrigation Expenditures . . . . . . 64 4.6 Development Expenditures on Research . . . . . . . . . . . 66 4.7 Expenditures Per Extension Worker . . . . . . . . . . . . . 67 4.8 Liquidity Credits to Agriculture . . . . . . . . . . . . . 68 4.9 Projected Expenditures on Agriculture . . . . . . . . . . . 70 4.10 Changes in Allocation of Agricultural Expenditures: 1995/96-2000/01 . . . . . . . . . . . . . . . . . . . . . 72 4.11 Private Sector Expenditures on Research in Selected Countries .................... . 79 5.1 Production Coverage of Import NTBs (1986-?1) . . . . . . 86 5.2 Production Coverage of Agricultural NTBs in 1991 . . . . 87 5.3 Structure of Protection in 1991 . . . . . . . . . . . . . . 89 5.4 Administered Price Structure for Sugar (April 1990) . . . . 98 5.5 Administered Price System for Wheat and Wheat Flour (November 1988) . . . . . . . . . . . . . . . . . . . . . 102 6.1 Projections of Agricultural GDP (Non-Forestry), 1988-2010 . 108 6.2 Growth Rates of Agricultural GDP . . . . . . . . . . . . . 109 6.3 Share of Agricultural GDP . . . . * . .... ...... 110 6.4 Trends in the Incidence of Poverty . . . . . . . . . . . . 111 6.5 Regional Location and Incidence of Poverty: 1987 . . . . . 112 6.6 Provincial Variation in some measures of Poverty . . . . . 113 - vii - TEXT CHARTS Pag. No. 2.1 Calorie Consumption vs. Income . . . . . . . . . . . . . . 16 2.2 Share of Various Foods in Total Calories Consumed . . . . . 20 4.1 Agricultural Development Expenditures . . . . . . . . . . . 62 6.1 Agriculture's Share of Non-Petroleum GDP . . . . . . . . . 119 6.2 Agriculture's Predicted Share of Non-Petroleum GDP ........ .................... 120 6.3 Agriculture's Predicted share of Total Employment . .......... ......... 121 BOXES 1.1 Women in Agriculture ............14 4.1 Benefits of Optimal O&M . . . . . . . . . . . . . . . . . . 65 4.2 Clove Marketing and the Costs of Intervention . . . . . . . 69 4.3 Requisite Adjustments to Land Policies . . . . . . . . . . 83 5.1 Indonesian Policies and the Agricultural Negotiations of the Uruguay Round . . . . . . . . . .. . .. . .. 105 6.1 Sources and Costs of Deforestation . . . . . . . . . . . . 116 6.2 Soil Management for Watershed Protecti,n . . . . . . . . . 118 List of References ......... . .... ......... 129 - viii - INDONESIA AGRICU¼ RAL TRANSFORMATIONs CHALLENGES AND OPPORTUNITIES Preface This sector review ..u based upon the findings of a mission 1/ that visited Indonesia during Septe..jer 16 - October 10, 1991, to examine the future of agriculture as the patterns of demand and structure of production transform with accelerating development of the economy. Chapter I provides an historical setting to the rest of the report, and briefly reviews the largely successful developments in the sector during th6 decades of 197e. and 1980s. Chapter II examines future food demand patturn. As incomes rise and nutritional levels improve. Demand projections for f.£ X .d livestock feed up to the year 2010 draw upon the experience of othe% countries. Chapter III evaluates supply conditions and prospects for vsr- agricultural commodities through the year 2010, and confirms that divertificatiov will nontinu; es an outcome of differential rates of growth of demand, and tecziical 4hange. This Chapter relies on agronomic experience, judgments of plant scientists, and resource availability rather than past supply trends. After evaluating demand and supply prospects, Chapter IV focuses on the roles -: t public and private institutions can play in realizing these prospec.a. Chapter V focuses on the future role of policy instruments and the ad4 qtments which are needed to facilitate the sector's changing role and objectives. Chapter VI concludes with a prognosis for the future of agriculture ini the overall economy and the generation of employment. It assosses the likely impacc of growth on poverty alleviation, and evaluates how the sector will position itself as structural transformation takes place during economic growth. Chapter VII identifies the major priorities for public investment, policy, and institutional strategies in facing the challenges for future development. I/ The mission consisted of Mrs. S. Canguly (task manager), Messrs. H. Eisa, D. Whittle, R. Polson (Bank staff) and J. Duloy, S. Magiera and P. Warr (consultants). The Government counterpart team was coordinated by Messrs. Alirabman and Faisal Kasryno. The assistance provided by this team and various Government departments is gratefully acknowledged. An early draft of the report was informally discussed with the Government in March 1992, and the green cover report was discussed in July 1992. Valuable inputs and guidance were also provided by the peer reviewers, Messrs. S. Barghouti, J. Anderson, J. van Holst Pellekaan, R. Topez (consultant), and several other Bank staff. - ix - INDONESLA AGRICULTURAL TRANSFORMATION: CHALLENGES AND OPPORTUNITIES Executive SummarV Historical Persnective i. Agricultural development in Indonesia during the 19709 and 1980s has been a success story. The agricultural sector, which contributes 21 percent to overall GDP, grew at 3.8 percent per annum between 1969-89, compared with a population growth of 2.1 percent. Farm food crops, which aceount for 60 percent of agricultural GDP, grew at 4.2 percent per annum during the asme period. Rice, the single largest component of the food crops subsector, grew at an even faster rate, 4.8 percent per annum, particularly during the 1979- 89 period. These growth rates are substantial considering that, in the 1970., not only was rice the principal agricultural import, but Indonesia was also the world's largest importer of rice. Since 1977, there has been a dramatic turn-around. Rice production, which grew by 3.5 million tons over the eight years prior to 1977, increased by 10.5 million tons over the following eight years. Farm non-food crops, which contributed 14 percent of agricultural GDP, also grew more rapidly in the 1980s than in 1970s (5.8 percont versus 2.2 percent in 1970s). Livestock (10 percent share in agriculture GDP) and fisheries (7 percent share) grew at 4 and 5 percent per annum, respectively, during the same two decades. ii. The impressive growth performance of the sector contributed substantially to an achievement of Indonesia's development objectives, not only of food security, low and stable prices, but also generation of employment and foreign exchange earnings/savings. Today, the sector employs 55 percent of the labor force, and foreign exchange earnings from agriculture account for 26 percent of non-oil exports. iii. Over the past two decades, the sector's most notable contribution has been in significantly reducing poverty. The policy of achieving self- sufficiency in rice was not only efficient, given Indonesia's comparative advantage in labor-intensive rice production, but was equally a policy for alleviating poverty, because rice production was the main economic activity and source of income of the.rural poor. In areas where poor soils are constraints to rice and other food crop production, tree crops contributed to employment and income generation for smallholder families. The incidence of poverty declined from over 40 percent in rural areas in 1976 to 14 percent in 1990, a decline of 65 percent. The number of poor people decreased by 50 percent overall, that is, a 60 percent decrease in rural areas and a constancy of the numbers in urban areas. More recent calculations of the severity of poverty, however, indicate that there might have been some underestimation of the rural nature of poverty. iv. These achievements were possible largely because of Indonesia's appropriate response to the oil boom and its success in containing the Dutch disease through a combination of macroeconomic management and sectoral policies. These policies included public investments in irrigation, research and extension, widespread promotion of high-y_elding varieties, and subsidized input packages, compensating for adverse terms of trade for tradeable goods, mainly agricultural. The input subsidies, initially, also helped induce farmers to move rapidly up the "learning curve" with respect to the benefits of fertilizer and other input application anu new high-yielding rice varieties. Administered price programs in conjunction with the trade policy regime helped achieve food price stability. v. The level of public expenditure on agriculture in Indonesia has been relatively high by developing country standards. During the 1984-88 period, it accounted for 9.3 percent of total budgetary expenditures, compared with 7.5 percent for 40 other devploping countries. Even at the height of revenue shortfalls caused by declining oil prices, agriculture was least affected by the tight fiscal policies initiated by Government. Following the oil revenue decline in 1986, the importance of foreign financing for agriculture expenditure increased. Expenditures on fertilizer subsidies and irrigation have remained consistently high (during 1983/84-1990/91), making up two-thirds of total agricultural development expenditures. In 1984/85, these expenditures reached 72 percent. vi. Inspite of significant trade policy reforms, agriculture remained regulated until recently. The principal instruments were: import licensing requirements (BULOG's and State Trading Corporations' exclusive right to import certain comodities), tariffs and a variety of export regulations (bans, taxes and licensing). Although the non-tariff barrier (NTB) coverage of domestic agricultural and manufacturing production is now quite similar at about 30 percent, nominal protection for agriculture is half that of manufacturing, 6 percent compared with 13 rercent. However, this masks a considerable variation within the sector. Forestty products are taxed through export regulations, while the nominal rates of protection (NRP) for livestock (due to tariffs) and food crops (due to licensing controls) are above the average of 6 percent. NRPs for sugar and soybean are well over 50 percent while those for rice and corn are close to zero. In spite of licensing controls, the price of rice has been approximately at parity with world prices during the last few years. The protection structure also escalates with the level of processing. The NRP for the food, beverages and tobacco category is 16 percent, lead.ng to a high effective protection of 190 percent. vii. Shortfa.ls associated with policy instruments utilized under the price and trade policy regime are: high budgetary . 'sts (e.g., Rp 700 billion for fertilizer subsidy in 1' '91) posing a fiscal burden; (b) inefficiencies in resource allrcation e.g., high subsidies resulting in excessive use of fertilizer and underpricing of resources (paras. xxvi and xxvii) leading to speculative demand for land and an inefficient use of water; and (c) a regulatory environment leading to rent seeking and cost inefficiency in marketing. Another limitation is the relatively narrow-based impact of the past policies and Investments. The positive impact has tended to be most significant for a single commodity-rice in one region-Java. - xi - sources of Growth and Suni-1V Pronsects in Future viii. Puture Market-driven Diverslficatign. As incomes rise and nutritional levels improve, diets are becoming more diversified. During the latter part of the 1990s and into the next contury, the per capita consumption of rice and other food staples is expected to decliea, while the growth in pet capita consumption of preferred foods (meats, fruits and vegetatles) will accelerate. The largest increase is expected to be in the consumption of intensively raised poultry. Livestock feed demand will also increase. Thusa over the next few decades, Indonesia is expected to have a more diversified demand pattern, driven mainly by market forces. ix. In terms of calorie consumption, the share of stap3- t.-Sans and root crops) is expected to decline from 73 percent in 1988 to nercont by the year 2010. The share of livestock products (all meats, eggs, f ih and dairy products), fruits and vegetables will incroase from 4.6 percent in 1988 to 8.9 percent in 2010. The transition out of food staples deperds very much on the rate of economic development-it will be far slower under a 4 percent GDP growth scenario and faster under a 7 percent growth scenario. x. Land and Water Resources. While there are physical constraints to expanding agricultural land on Java, the constraints off-Java are mainly economic, social and environmental. In the context of rice production, a major issue is the cost of bringing new land under irrigation, and of realizing high productivity on the newly irrigated land because of soilst terrain and hydrological constraints. This report suggests that the expansion of high-cost irrigation should be slowed down in the near future. During the next 5-year plan period, about 35,000-50,000 ha per annum may be required to be brought under irrigation, to offset primarily the loss of land to non-agricultural uses, particularly in Java. The emphasis should be on completing works in existing command areas of surface irrigation, and realizing the potential for groundwater development by the private sector. Issues related to efficiency of water use and water quall-y will become increasingly important. It is also assumed that drinking water usage will continue to have first claim on available water supplies. Basin-wide improvement in water conservation and an integrated water resource management will be critical, particularly during the dry season and near the urban areas. This will require a detailed review of water balances in the metropolitan regions and basins. xi. Scone for Yield Imyrovwqn_t. The shifting of the rice yield frontier would come from develocrnat and adoption of improved high yielding varieties and introduction of hybrid rice (next 10 years), change in plant architecture (10-15 years), and incorporation of biotechnology and improvement of crop management practices. Likewise, the widespread adoption of hybrid corn has good potential. With regard to soybean production, the rain constraint is technical/agronomic. A short maturity period (lses than 85 days as compared to 120-150 days for some of the US and Brazilian varieties) is needed to fit into rice-dominated crop rotation patterns. Soybeans and other legumes, however, are useful for enhancing the nitrogen status of soils. Soybean production can be enhanced to meet domestic requirements for tempo (soybean curd) and tahu (molded soybean cake), if not for livestock feed. Sugarcane occupies the land for 12-14 months with the farmer receiving income - xii - from a single crop. On the other hand, farmers on the sara irrigated land can grow two crops of high yielding varieties of rice, followed by a secondary crop, and earn more income. Thus far, the economics of growing sugar cane in rained areas are not favorablo due to poor soils, and low cane and sucrose yields, and this area needs further research. xii. SuDglY Prosvecte. Rice production is projected to inorease at an annual average rate of about 2.0 percent until year 2010. Sel'-sufficiency can be sustained without the need for c protectionist rice policy. Domestic producer prices should continue to follow the long-term trends in world prices. Shortfalls may occur in drought years, necessitating iaports in some years. Production increases are expected to come from yield incregses following the introduction and adoption of new varieties. These neo: varieties will also be available to competitors and therefore probably will not confer a competitive edge on Indonesian exports. xiii. Indonesia is projected to emerge as a significant producer and an exporter of corn. The exportable surplus of corn could be less, if the corn use in feed is higher than that suggeoted by the Government data sources. Full import replacement for soybeans may not be feasible because of agronomic constraints. Livestock .nd horticulture production are conservatively estimated to keep pace with increases in future domestic demand. An annual growth rate of 5 percent for fisheries products with exports increasing at 8 percent per annum seems feasible. Growth rates for major tree crop products are based on the sector -'eview 1/ undertaken by the Bank in 1989. The Outer Islands are well-suited to the production of tree crops on a sustainable basis, and these investments continue to be financially and economically sound. Indonesia has ample production and market (domestic and export) potential. l/ xiv. Diversification is thus towards products with (a) high income elasticities of demand and (b) high land-use intensity. These notably are horticulture, fisheries and small livestock (poultry) products. Grains, particularly rice and corn, will continue to dominate, but rice will no longer be a prime mover of the sector or of the increased value-added activities. Good prospects for retaining self-sufficiency in rice through higher yields reinforces the view that it is not necessary to spend enormous resources to keep land in rice production. Given the uncertainties of the :uture course of the world economy and the associated price movements, it is argued that a ./ World Bank, Indonesia: Strategies for Sustained Development of Tree Crops. Report No. 7697-IND, December 7, 1989. The strategy outlined in this report, to fully realize the potential, includedt (a) deregulation of marketing and trade in edible oils (undertaken by the Government in 1991); (b) elimination of barriers to private sector development, including development of infrastructure, and streamlining of procedures for land acquisition; (c) improvements in access to planting material by smallholders; (d) increased emphasis to replanting, because of the aging structure of rubber tree stock; and (e) improvements in rubber quality, which is critical to Indonesia's ability to meet future import demand of industrial countries. - xiii - flexible agricultural sector is needed, which can respond to the opportunities presented by changes in world market and prices, as they occur. Proanosis of the Sector Xv. As the patterns of demand and structure of production transform during economic &rowth, the growth of agricultural GDP from 1990 onward is likely to stabilize at around 3 percent per annum. Within agriculture, the share of food crops is projected to decline from 68 percent in 1988 to 60 percent in year 2010, with non-food crops holding steady at 14 percent share, and livestock and fishery products increasing their share by 50 percent each (10 to 15 percent and 8 to 12 percent, respectively). xvi. A growth of 3 percent per annum in agricultural GDP is still high relative to total popalation growth, rural population Browth and growth in most other countries. Together with growth in non-agriculture activities in rural areas, agricultural growth should continue to have a positive role in reducing poverty. However, poverty is increasingly an urban problem, particularly on Java, when once it had been almost entirely a rural one. This does not, of course, reduce the importance of a concurrent reduction in rural poverty, which is needed to prevent the urban poverty from getting worse. Successful agricultural development is needed to generate rural prosperity which, in turn, generates off-farm employment. A strategy to reduce poverty through agricultural development car. be successful on Java where farm families have an adequate resource base, but may be less relevant off-Java where the resource base may be inadequate. Opportunities exist in tree crops, fisheries, livestock and forestry off-Java. The reduction of rural poverty off-Java requires agricultural growth, since the poor in these areas have limited off-farm income possibilities. The issue is one of devising approaches which do not deplete the fragile resource base and which generate developmental linkages to local econ,mies. This is important not only in off- Java where concerns exist about deforestation,2/ but also in Java, where concerns are over upland degradation. xvii. Sector developments, as envisioned in this report, are likely to be environmentally sound, .ith low rate of growth of forestry products, growth for food crops coming from yield-increasingvarieties, and no major expansion of irrigation. When appropriately sited and well managed, tree crop 2/ Deforestation is taking place at a rate estimated between 700,000 - 1.2 million ha per year. The sources of deforestation include smallholder conversion, development projects, logging, and fire losses. Net loss to the economy in terms of all merchantable forest products could amount to as much as $1 billion each year. Catchment (soil and water) values off-site can be significantly affected by deforestation. Large-scale clearing for agriculture produces smoke and carbon dioxide, which are considered to be major contributors to global warming. Forest destruction also leads to loss of biodiversity. These and other aspects related to the conservation of tropical forests at the same time they are utilized for their production capability in a truly susta'nable manner, will be addressed in a separate Forestry Sector Review, to be undertaken by the Bank in end-1992. - xiv - production can utilize, and in fact, stabilize marginal land in critical areas for which few other sustainable land uses may be available. Problems to be tackled include depletion and pollution in fishery areas, urban- and industry- based water pollution, soil erosion causing watershed degradation, and the effluents from agro-proc*esing. xviii. Agriculture will continue to contract as a pr)portion of total output as well as total employment. However, the latter will tend to lag. Attempts to slow the movement of labor out of agriculture through price interventions will be largely ineffective. Agriculture's employment share is quite insensitive to movements in relative commodity prices. The policy emphasis should be on enhancing productivity of labor throughout the economy, and not on finding ways for agriculture to absorb surplus labor. Expansion of employment opportunities outside agriculture need not mean migration from rural to urban areas. Investment. Policy and Institutional Ad1ustments xix. Public Investment. Future challenges suggest that the pattern of public expenditures needs to be altered, with less spending on fertilizer subsidies, and new Irrigation development, and more on research, extension and Infrastructure. An approach may be to utilize the resources for poverty alleviation and regional balance, as needed for the Eastern Islands. This could entail investments in infrastructure or in other economic activities (including agriculture) as identified to be critical for the development of the local economy. Alternatively, savings, if any, could be used to contribute to macroeconomic stability. A future agricultural expenditure envelope is presented in the report. Priorities for research include: introduction and adoption of hybrid rice and new varieties, use of leguminous crops in crop rotations to prevent degradation of the paddy environment, corn improvement programs, quality of horticultural crops, fisheries stock assessment and management, aquaculture feed research, improvements in animal husbandry, provision of more and better forages, and control of livestock and aquaculture diseases. To meet future needs of the various regions, AARD's focus must shift away from its primary emphasis on commodity-oriented research programs. Commodity research needs to be undertaken in the context of farming systems, based on agro-ecological zones. Greater concentration on non-rice activities will require not only a broader range of skills, but also a more geographically dispersed research infrastructure. Adoption of future technologies will require Improved farmer training, and increased travel and other allowances for extension agents. Future growth in agriculture will require more focus on Infrastructure (roads, ports, electricity, communications etc.) development particularly in upland areas and the Outer Islands. cxK Improving Atricultural Incentives. As in the past, supportive macroeconomic policies will be needed to maintain the competitiveness of the sector on the International market as well as to spur domestic growth. In addition to phasing out input subsidies (in particular, a phase out of fertilizer subsidy by 1995) and moving these resources to investments on research and infrastructure, a further dismantling of the administered price and regulatory trade regimes is needed. Regarding rice policies, this report contends that: - xv - (a) The distribution of rice to budget groups involves unnecessary marketing costs since rice It re-sold on the domestic market. Also, BULOG purchases are destabilizing when domestic rice supplies are short. This program should be phased out gradually over a 3-year period and as part of a civil service pay reform package. An alternative would be to change the target group, to low income households as part of a poverty alleviation program. (b) The role of the private sector in marketing rice would be increased and costs reduced by limiting BULOG interventions to those areas, where competition in the market needs to be ensured. This would eliminate the need for a large number of sub-DOLOGs. To provide incentives for private storage, intervention prices should be increase; during the first few months after the main harvest. (c) The domestic price should continue to be maintained at world parity. xxi. Protection of feed ingredients, soybeans and soybean meal for example, taxes some of Indonesia's most promising agro-processing industries, including feed milling, intensive poultry production and shrimp farming. High feed costs also tax the pork, dairy and beef industries. Labor-intensive tempe and tahu producers are taxed by high soybean prices. It is, therefore, recommended that: (a) Licensing restrictions on soybean imports be eliminated and replaced with a tariff identical to that for soymeal. (b) Soymeal imports remain deregulated and opened to the private sector under the same tariff structure as for BULOG. (c) The tariff on soymeal be as low as possible to encourage the development of feed milling and livestock industries. (d) The fee structure for the crushing mill be eliminated and the industry opened for private investment and increased competition. xxii. Sugar is another highly protected commodity and is a key ingredient in many processed food products. Deregulation should initially focus on state ownership of the milling industry and BULOG's control over the distribution of refined sugar, i.e., opening of the industry to private investment and increased competition. An open tender system would eliminate the high commissions paid to agents to handle sugar Imports. Over the longer term, sugar prices should be lowered to import parity. xxiii. With regard to wheat and flour pricing and trade policies, it is recommended that flour prices be set at world market parity. In case there is a rice deficit, Indonesia would be better off importing wheat, which is a cheaper calorie source of food energy. If a rice surplus develops, Indonesia could export rice at higher prices and gain the value-added from processing imported wheat at home. This report contends that there is no reason for subsidizing wheat to mills while Imposing a surcharge on consumers. Major deregulation options includes elimination of licensing controls over flour imports, the administered price system, investment restrictions in flour - xvi - milling and all licensing requirements in the distribution chain. BULOG's monopoly control over Imports should be eliminated and, if necessary, replaced -,ith a tariff. xxiv. The Government should eliminate the implied subsidy, for cassava, to non-EC markets and garner part of quota rents (which presently accrue to cassava exporters in Indonesia and importers in non-EC markets) by auctioning the EC quotas. Regional restrictions on trade, which raise the cost of Indonesia's exports both directly and indirectly by preventing the development of an integrated national market, should be eliminated. xxv. Institutional and Regulatory Framework. There wil'l be a continuing need for more efficient coordination between the Agency for Agricultural Research and Developmen (MAARD), extension organizations and farmers. The AARD needs to continue to upgrade its capability in articulating its regional research programs, improving linkages with the private sector, strengthening information technology, particularly networking, to link its regional research programs with other International Agricultural Research Centers (ZARCs) and research organizations, in addition to the International Rice Research Institute (IRRI) and the International Service for National Agricultural Research (ISNAR). Regarding extension, a decentralized approach based on provincial and local resources needs to be fcstered. Skills improvement and greater use of modern communications technology as part of the outreach service to farmers, should be undertaken. xxvi. The Government's regulatory role with respect to the environment should increase in the future. In addition to appropriate pricing of land, water and forestry resources, regulatory standards are needed to control effluents from agro-processing, to prevent depletion and pollution problems in fishing areas, and to control water quality. More specifically, with regard to the land policy framework, a recent World Bank report 3/ proposes a system of land resource allocation, which relies more on market prices, and a role for the Government to protect the environment and provide an enabling environment for the market to operate efficiently. This will require collection and dissemination of information and registration of land right ownership. The report calls for adjustments to policies requiring a change in legal and regulatory framework (including a simplification of land regulations and, over a longer term, removal of restrictions on lease periods and ownership of land rights, needed in particular to stimulate private investment in agro-processing), improving land information systems, accelerating land registration/titling, and formulating a transparent resettlemenit policy at the national level, based on fair compensation. xxvii. Also, an array of simple low-cost approaches to soil conservation, including farmer-controlled and farmer-instituted agronomic and vegetative measures such as agro-forestry, inter-cropping and other practices are needed in the uplands to protect watersheds. Greater success results when conservation programs and extension services make information available on a menu of techniques adapted to local circumstances, from which farmers can select to get the best results under their specific conditions. Regarding 3/ World Bank, "Land Resources, Management, and Planning", June 26, 1991. - xvii - water pricing, the longer term strategy should be to charge water user groups the wholesale cost of water at secondary outlets. In the meantime, the collection of irrigation service fee on an area and crop basis, and the turnover of small schemes (less than 500 ha) to the water user associations, should be extended on a nation-wide basis. xxviii. While the Government would continue to provide infrastructure to enable further development of the private sector, GOI may want to revisit its role in production, marketing, and in the provision of inputs and support services. The public estates (PTPs), engaged in plantation-based estate crops, should enter into joint ventures with the private sector, and eventually privatize, to improve management, efficiency, and.gain access to financing. The future role of BULOG in the trade, domestic distribution and storage of rice and for the other commodities is discussed in paras. xx-xxiv. Regarding input supplies, Government should privatize profitable urea factories and induce grsater competition in the wholesale and retail distribution of fertilizer. The roles of public and private sectors in seed production and marketing (including an improved access and provision of planting materials to tree crop smallholders) needs to be redefined, and the policy guidelines (including a phase out of seed subsidies) conducive to private-sector involvement, implemented. Government must monitor the vested interests of and abuses by the private sector in promoting pesticides, and continue to support the Integrated Pest Management Program. Use of small tractors, pumps, sprayers, harvesting and threshing equipment is likely to increase with higher wages in agriculture and increase in off-farm employment. Restrictions on private-sector manufacturing and marketing of such equipment should be relaxed. GOI may alac wish to consider creating a private-sector liaison unit, with responsibility to "screen" AARD research findings, and research programs relevant to private sector interests. xxix. Such actions on the domestic front are needed to enable the sector face the challenges and utilize future development opportunities. Despite the inevitable structural transformation, agriculture and more generally the rural economy will play a central role in supporting growth, employment and incomes. This will require a competitive, flexible and diversified sector. I. HISTORICAL PERSPECTIVE ON AGRICULTURAL DEVELOPMENT - A SUCCESS STORY 1.1 Overview. This chapter provides an historical setting to the rest of tne report. A reviow of agricultural sector developments during the past two decades shows that Indonesia has achieved many of its development objectives. This is due to: (a) an appropriate policy response to the oil boom which successfully contained the Dutch disease;1/ and (b) a combination of macroeconomic management and sectoral policies. The impact of these policies was relatively narrow-based, being most significant for rice on Java. The remaining chapters of the report highlight the challenges and opportunities for the sector as the patterns of demand and structure of production change with economic growth in the next two decades. Agriculture and the Contained Dutch Disease 1.2 Indonesia's Policy Response. Compared with other oil exporting countries, Indonesia's agricultural sector performed quite well in spite of the oil shocks of 1973-74 and 1978-79.2/ While Indonesia is a minor producer of oil, its oil revenues are critical to national development. Oil revenues accounted for about 75 percent of export earnings while 4-.axes on oil companies provided 65 percent of direct government revenues at the height of the boom years. While oil price increases resulted in substantial revenue gains for all oil exporting nations, Indonesia's policy response was cautious and favored continued agricultural sector development. Excess accumulation of debt was avoided and the benefits of oil revenues were spread among both rural and urban areas. A 33 percent devaluation of the rupiah in November 1978 further protected the domestic tradable sector from the effect of the oil boom by improving the competitiveness of tradable goods. 1.3 International Comparisons. Table 1.1 provides comparisons of Indonesia's performance with four other OPEC countries (Nigeria, Algeria, Venezuela and Ecuador) as well as Malaysia. Each of these countries experienced increased revenues during the oil boom. Indonesia's oil windfall gain of $4.2 billion in 1974 was 16.5 percent of GDP. Between 1974-78 and 1979-81, Indonesia's index of agricultural output increased by 13 percent, while those of most other oil exporting countries had declined. By 1982/83, Indonesia's index in agricultural output was 117. Its GDP growth rate I/ The Dutch Disease. For an oil exportlng country with a large agricultural sector, increases in oil price lead to a change in the structure of production from tradable goods (mainly agricultural) to non- tradables (construction and services). The ratio of tradable to the non- tradable goods prices declines, causing a contraction in the output of tradables and an expansion in the output of non-tradables. Agricultural growth rates are lower than in the absence of the oil boom as both labor and capital seek higher incomes in other sectors. Additionally, factors used intensively in the production of tradable commodities lose in absolute terms while those used intensively in the production of non- tradables gain. 2/ Gelb, Alan et al. Oil Windfalls: Blessing or Curse, 1988. -2- Table 1.1s COMPARATIVE PERFORMANCE OF INDONESIA AND OTHER OIL EXPORTING COUNTRIES Indonesia Nigeria Algeria Venezuela Ecuador Malayaia Population (million 1990) 181.6 117.5 25.1 19.7 10.6 17.8 Real per capita GNP ($US): 1980 480 1,020 1,960 4,070 1,260 1,680 1989 500 249 2,311 2,471 987 2,136 Oil Windfall (1974) ($ billion) 4.2 7.9 3.4 5.6 0.8 n.a. As percent of GDP 16.5 26.6 29.0 21.3 22.8 n.a. Index of Agric. Output 1974-78 100 100 100 100 100 n.a. 1979-81 113 100 93 98 109 l.a. 1982-83 117 92 79 97 104 n.a. Real GDP Growth Rate (2 p.a.) 1965-80 7.0 6.1 n.a. 3.7 8.8 7.4 1980-89 5.3 -0.4 3.3 1.0 1.9 4.9 Ave. Annual Inflation Rate (2) 1965-80 35.5 14.7 10.5 10.4 10.9 4.9 1980-89 8.3 14.2 5.2 16.0 34.4 1.5 Sources: World Bank Estiaates. remained steady around 5 to 7 percent per annum while the GDP growth rate of all other countries, except Malaysia, declined sharply. Indonesia was also able to control inflation (from 35.5 percent p.a. during 1965-80 to 8.3 percent during the 1980-89 period). Prudent macroeconomic management, public sectox investments in supportive infrastructure, especially irrigation, and provision of subsidized inputs were critical to the growth of Indonesian agriculture during this period, while other oil exporting countries faced a general contraction in their agricultural output. Development Obiectives Laraelv Achieved 1.4 The agricultural development strategies of GOI over the past two decades were consistent with the overall framework of national economic development and were primarily aimed at: (a) stimulating production and growth in rural incomes and employment to reduce rural poverty; (b) export expansion and import substitution to earn/slve foreign exchange; and (c) ensuring long-term food security. 1.5 Contribution to Overall Growth. The growth of agriculture has been particularly impressive when viewed against the collapse of the mid-1960s and subsequent recovery. By 1974, with a population of 129 million and per capita income of US$200, Indonesia was the world's largest importer of rice in a thin and volatile world market. The country depended overwhelmingly on foreign sources of supply for its national staple during this period. But the growth- inducing policies (Sections IV and V) initiated during the early 1970. -3- generated substantial benefits in later years and rice self-sufficiency was achieved in a relatively short period of time. 1.6 During the two decades of the 1970s and the 1980s,3/ agricultural GDP grew at an average annual rate of 3.8 percent. This was well above the growth rate of population (2.1 percent) and exceeded that in most other developing countries with similar resource endowments and population pressures. The sector contributed the largest single share of GDP in 1969 (36.8 percent), though by 1989 its contribution had declined to 20.6 percent. The declining share of agriculture was due mainly to the increasing contribution from maaufacturing and industry to overall economi.c output as the country went through a rapid economic transformation (Table 1.2). Table 1.2: SHARES OF GDP AND SECTORAL GROWTH RATES Shares (S) Real Growth Rates (S n.a.) 1969 1970 1975 1980 1985 1989 1969-79 1979-89 1969-89 Agriculture 36.8 35.2 28.4 24.6 22.7 20.6 3.8 3.4 3.8 Mining (mncl. oil) 22.7 23.7 26.9 24.1 18.2 15.6 10.1 0.4 3.9 Manufacturing 6.1 6.1 6.4 11.0 15.8 18.5 12.2 12.9 14.0 All other sectors /a 34.4 35.0 38.3 40.3 43.3 45.4 9.3 6.5 8.2 Total GDP 100.0 100.0 100.0 100.0 100.0 100.0 8.1 5.4 6.7 Population 114.9 119.2 131.4 147.5 163.9 181.6 1.9 2.3 2.1 (million) L Includes electricity and gas, construction, transport and communications, banking and other services. Source: BPS and Bank estimates. 1.7 Contribution to Sectoral Growth. Farm food crops, comprising rice and palawija 4/ crops, constitute the largest single component of agricultural GDP (Table 1.3). Between 1969-89, the farm food crops subsector grew at an average annual rate of 4.2 percent. Consequently, the farm food crop share of agricultural GDP has remained fairly steady at 60 percent over the past two decades. 1.8 Farm non-food crops accounted for 12.5 percent of agricultural GDP in 1969. The expansion of tree crop production, which began in the early 1980s, was largely responsible for the increase to 13.6 percent in 1989. The increase was due to government programs to expand tree crop area combined with the introduction of high yielding clones to producers primarily off-Java. The livestock (including livestock products) share of agricultural GDP averaged 31 In this report the two decades cover the period 1969-1989, unless specified otherwise. A/ Major palawija (secondary) food crops covered in this report are corn, soybeans, groundnuts, sweet potatoes and cassava. -4- Table 1.3: SUBSECTOR SHARE OP AGRICULTURAL GDP AND GROWTH RATES (constant 1983 prices) Shares (2) Growth Rates (Z n.a.) 1969 1970 1975 1980 1985 1989 1969-79 1979-89 1969-89 Farm food crops La 60.0 59.0 59.3 58.9 62.1 60.9 3.7 3.8 4.2- Farm non-food crops Lb 12.5 11.9 10.1 11.2 13.4 13.6 2.2 5.8 4.9 Estate crops /c 3.0 3.0 3.0 3.0 2.6 2.7 4.3 2.2 3.3 Livestock 10.3 10.3 11.2 9.7 10.6 10.6 2.7 4.7 3.8 Fishery 6.6 6.8 6.2 6.8 6.9 7.3 3.9 4.5 4.6 Forestry 7.6 9.0 10.2 10.4 4.4 4.9 7.3 -5.5/d -1.5 Total Aariculture 100., 100.0 100.0 100.0 100.0 100.0 /a Includes fruits and vegetables. i Smallholder tree crops. c Large estate tree crops. Il Export restrictions caused forestry value added to decline. Source: BPS. slightly above 10 percent. The growth of production averaged 3.8 percent per annum over the past two decades, but has been much higher in recent years. The fishery subsector, while contributing only 7 percent of agricultural GDP in 1989, has been growing rapidly over the past two decades, at 4.6 percent per annum. 1.9 Contribution to Labor Absorption. Agriculture has been the single largest source of employment for the last two decades (Table 1.4). Agricultural employment rose from 27 million people in 1971, to 32 million in Table 1.4: EMPLOYMENT BY MAIN INDUSTRY, 1971-89 (in millions) Sector 1971 Z 1980 X 1982 X 1989 Z Agriculture 26.5 64.2 31.6 61.1 31.6 54.6 41.3 53.9 Mining and quarrying 0.1 0.2 0.1 0.1 0.4 0.7 0.5 0.7 Manufacturing 2.7 6.5 3.8 7.4 6.0 10.4 10.6 13.7 Electricity, gae & water 0.0 0.1 0.1 0.1 0.1 0.2 0.1 1.3 Construction 0.7 1.6 0.8 1.6 2.1 3.6 1.8 2.2 Wholesale and retail trade 4.3 10.3 7.7 14.8 8.6 14.9 10.9 14.2 Transportation 1.0 2.3 1.3 2.5 1.8 3.1 2.2 2.9 Financing and real estate 0.1 0.2 0.1 0.1 0.1 0.2 0.4 0.5 Public services 4.1 10.0 6.4 12.4 7.1 12.4 8.9 11.6 Total 41.3 100.0 51.7 100.0 57.8 100.0 76.7 100.0 Source: BPS. -5- 1980, and to 41 million in 1989. However, employmer.t in the service and manufacturing sectors has grown much faster. Consequently, agriculture's share of the labor force has gradually fallen, from 64 percent in 1971 to 54 percent in 1989. 1.10 Some of the structural changes occurring in the economy and their impacts on labor absorption in agriculture are discussed in detail in paras. 6.17-6.19. While growth in employment decelerated in all sectors during 1980-85, it increased in agriculture. The highest employment elasticities during this period were in trade/transport, followed by construction and agriculture as indicated in Table 1.5. Table 1.5s IMPLIED EMPLOYMENT ELASTICITIES FOR INDONESIA GDP Growth rates (X p.a. at constant Employment growth Employment (1983) grices) rates (% p.a. La elasticities /a 1971-80 1980-85 1971-80 19E 5 1971-80 1980-85 Agriculture 3.8 3.1 1.3 1.9 0.3 0.6 Manufacturing 13.9 6.4 4.8 2.8 0.3 0.4 Trade/transport 8.6 4.6 5.0 5.0 0.6 1.1 Construction 14.6 3.3 8.6 3.2 0.6 0.9 Government/services 9.4 8.3 8.6 3.2 0.7 0.1 Total Non-oil 790.4 0.5 i/ Data not available for earlier years. Source: BPS and World Bank staff estimates. 1.11 Contribution to novertX alleviation. The incidence of rural poverty declined from over 40 percent in rural areas in 1976 to just over 14 percent in 1990. A major part of the reason for the reduction in poverty was increased incomes in agriculture. Detailed analysis of the 1984-87 period, for example, reveals that 60-70 percent of decline in poverty came from households primarily engaged in agriculture. The other part of the reason was due to rural-urban migration. In 1976, 18 percent of poor people were located in cities and 82 percent in rural areas. By 1990, this had changed to 35 percent in cities and 65 percent in rural areas. More detailed analysis of rural/urban and regional/provincial incidence of poverty is discussed in paras. 6.7-6.12. 1.12 Contribution to Foreian Exchante Earnings/Savings. Indonesia has a diversified agricultural resource base suitable for exports. Given the appropriate policy regime, the sector can be competitive on international markets. Many export commodities are both labor and land intensive. Indonesia capitalized on this comparative advantage by taking advantage of its low labor -6- costs in general and relative land abundance outidde Java, for the cultivation of export commodities and the siting of export-oriented industries. GOI has adopted a policy of growth in the non-oil economy as a priority, with particular emphasis on agricultural exports. Policy reforms, i.e., export incentives, simplification of domestic regulations and the gradual removal of trade barriers, have been instrumental in export expansion, the generation of foreign exchange and the provision of income earning opportunities for the rural labor force. 1.13 Exiyort ExDansion. The contribution of agriculture to export earnings is summarized in Table 1.6. Between 1974-90, export of agricultural products expanded at an average annual growth of 3.0 percent, more than double the growth of 1.2 percent for imports. The largest growth in agricultural exports occurred in processed agricultural products (11.3 percent), followed by fish and shellfish (6.0 percent) and fruits and vegetables (4.8 percent). In more recent years, shrimp exports in particular, have increased very rapidly. At the height of the oil boom in 1981, agricultural exports accounted for about one-half of non-oil exports. With the decline in oil prices in the late 1980s, the growth of agricultural exports relative to total exports more than doubled, from 9 percent in 1981 to 21 percent in 1988. Falling primary commodity prices and a strong growth in the manufacturing sector led to a decrease in the share of agricultural exports to total exports, 16 percent in 1989. 1.14 Import Substitution. Table 1.7 indicates that between 1974-90, imports of cereals, notably rice, some milk and dairy products and processed foods remained relatively low or declined over the period, due mainly to increased import substitution. The largest expansion in imports occurred in vegetable oil, livestock products and animal feeds, reflecting a strong, positive increase in domestic demand, both for consumption and for domestic value-added activities. Imports of vegetable oils and associated products grew by 11.5 percent during the period, about double the increase in livestock products and feeds (5.7 percent). The deregulation of price and trade regimes (Section V) has been essential in increasing the competitiveness of the sector and leading to an increase in value-added activities. Policy Instruments 1.15 A combination of macroeconomi. management and sectoral policies were key factors in achieving agricultural development objectives. At the macroeconomic level, adoption of a flexible exchange rate policy, austere fiscal and monetary policies which helped contain inflation, and liberalization of foreign trade were essential in increasing the international competitiveness of Indonesia's agriculture and spurring domestic economic growth. 1.16 Macroeconomic Policies. A blend of exchange rate, monetary, fiscal and trade policies was used to achieve growth in agriculture over the past two decades. Exchange rate policies, particularly during the second oil boom, were effective in restoring the competitiveness of the agricultural sector. Prior to 1986, the exchange rate was held fixed for long periods. As a result, expanding oil revenues led to creeping overvaluation of the exchange -7- Table 1.6: AGRICULTURAL EXPORTS, 1974 - 1990 (US$ Million) Annual Growth Rate Commodity Group 74-76 79-81 84-86 88-90 1974-90 Tree and Beverage Crops 829.9 1,358.7 1,856.9 2,143.2 2.32 Rubber 446.4 591.9 794.6 1,039.5 2.04 Palm oil, other oils/ 160.8 127.6 253.8 473.2 3.01 products Coffee 168.7 540.2 650.4 474.0 2.43 Tea 54.1 99.0 158.2 156.5 2.76 Food Crops and Feeds 60.2 95.0 107.6 115.1 1.44 Rice La - 1.5 32.7 4.2 4.13 Cassava# maize and 60.2 93.5 74.9 110.9 1.09 feedstuffs Processed Products 5.2 33.3 67.5 129.0 11.31 Cocoa and chocolate 3.0 27.7 59.5 98.6 12.96 Other processed foods 2.2 5.6 8.0 30.4 7.99 Fruits, Vegetables and spices 69.0 130.0 218.9 384.9 4.78 Fresh fruits and Vegetables lb 22.6 58.9 70.0 199.3 5.97 Pepper and spices 46.4 71.1 148.9 185.6 3.95 Animal and animal products 9.1 8.0 11.4 39.9 3.83 Fish and shellfish 103.8 141.4 263.5 796.9 6.01 Tobacco and products 37.7 56.9 53.3 99.3 2.05 Others 8.8 21.1 33.2 40.4 4.09 Total Exports 1,123.8 1,844.5 2,612.5 3,748.7 3.04 Total Imports 741.9 1,529.3 995.4 1,504.0 1.15 Net Balance 381.9 315.2 1,617.1 2,244.7 6.27 Memo: Non-forestry agricultural exports as 2 of: 1981 1985 1988 1989 All exports 9 14 21 16 Non-oil exports 48 41 33 26 Agricultural GDP /c 10 13 21 18 1979-1990 only. ii Inclusion of cassava chips and pellets are, perhaps, overstating the growth. lz Excludes forestry. Sources BPS. Table 1.7t IMPORT OF AGRICULTURAL PRODUCTS (US$ Million) Annual Growth Rate Commodity Group 74-76 79-81 84-86 88-90 1974-90 Cereals 470.9 654.4 346.2 323.7 -1.01 Rice 383.6 497.7 48.9 32.9 -3.88 Wheat and flour 78.2 141.6 272.0 269.6 3.42 Other cereals 9.1 15.2 25.3 21.2 2.24 Vegetable Oils and Seeds 11.7 57.7 152.1 274.9 11.48 Soybeans, other oil seeds 7.7 35.4 118.1 160.9 11.27 Vegetable oils/products 4.0 22.3 34.0 114.0 11.57 Livestock Products and Feeds 36.2 139.5 190.6 283.7 5.70 Milk and dairy products 32.0 76.5 63.5 75.3 1.68 Animal and animal product 3.6 20.1 21.1 30.4 5.69 Animal feedstuffs 0.7 42.9 160.0 177.9 30.46 Fish and shellfish 4.7 3.4 4.7 5.1 0.36 Sugar 56.7 292.5 10.4 97.8 -0.98 Fruits and vegetables 12.7 75.3 27.2 55.5 2.55 Processed foods/beverages 60.7 107.0 60.7 39.5 -1.06 Tobacco 12.8 26.2 14.5 34.6 1.69 cotton 72.6 167.9 188.7 388.0 4.21 Others 2.9 5.4 0.4 1.1 -2.64 Total Imports 741.9 1,529.3 995.4 1,504.0 1.15 Source: BPS. rate in real terms. In order to restore competitiveness of the tradable goods sector, particularly agriculture, the GovernAent embarked on periodic devaluations of the currency. The rupiah was devalued by 33 percent in November 1978 as a measure to make exports more competitive by protecting agricultural tradables from the effect of the oil boom (para. 1.3) and of the declining primary commodity prices in the world market. The rupiah was also devalued by 28 percent in March 1983 and again by 31 percent in September 1986. Since September 1986, the last major devaluation of the rupiah, nominal exchange rate has steadily depreciated against the US dollar, preventing an appreciation of the exchange rate in real terms. 1.17 Monetary and fiscal policies have had the combined effect of supporting growth in the agricultural sector. 001, while scaling back large capital intensive projects and maintaining tight control on spending in non- agricultural sectors, maintained a high level of public expenditures in agriculture (Section IV). These expenditures wers critical in maintaining the momentum of agricultural sector growth begun in the early 1970s. There has also been improved monetary management of inflationary trends in the economy. 1.18 GOI trade policy reforms over the past decade consisted of reductions in tariffs and the elimination of many Non-Tariff Barrier. (NTBe) (paras. 5.7-5.18). Deregulation packages introduced during the mid to late 1980s and early 1990s represented significant movements away from lnward- looking policy of domestic protection during the 19709. Beginning in 1985, GOI implemented major tariff reforms and reorganized custom and porte operations more efficiently. Later reforms consisted of the elimination of various types of non-tariff barriers on both exports and imports. Additionally, regulations governing foreign investments were relaxed. Although certain trade restrictions remain (Section V) ,the cumulative offact of these policy reforms ha. been to reduce the anti-export bias of the early 1970. and to spur export growth. Non-forestry agricultural exports were particularly responsive to these policy changes, growing from US$2,592 milloon in 1985 to US$4,063 million in 1988, an increase of over 36 percent (Table 1.6). 1.19 GOI policies to stimulate production and increase rural incomes also included public investments in irrigsation, research, extension and provision of subsidized inputs (Section IV) and price stabilization programs (Section V). ImDact - Primarily Rice on Java 1.20 ReRional Impacts. Table 1.8 provides regional data for the four production regions covered in this report.5/ There are significant regional differences in levels of endowments, including: (i) population; (Li) land resources; and (iii) levels of economic development. Java, with the smallest land area (6.9 percent) and the highest population density (812 persons/kmI), has the greatest population pressure on arable land. The population growth rates are higher outside Java than on Java. These differences in endowments have implications not only for explaining the past performance of agriculture but also for the development of future strategies for growth and diversification. 1.21 Agricultural productioru in Indonesia is characterized by private smallholder plots with less than 0.5 ha (Table 1.9). This is particularly the case in Java where more than 50 percent of all farms are less than 0.5 ha. in comparison, 29 and 25 percent of all farms on Sumatra and Sulawesi, respectively, are less than 0.5 ha. 1.22 The island of Java has historically been at the center of agricultural development in Indonesia and accounted for the greatest proportion of agricultural investments over the past two decades. Java's contribution to GDP has been quite substantial, averaging nearly 55 percent of both overall GDP and agricultural GDP between 1979 - 1989. Sumatra, with about 25 percent of the total land area of Indonesia, averaged nearly 30 percent of total value-added and 24 percent of agricultural value-added over the same period. Sulawesi and the rest of Indonesia together accounted 5/ Unless otherwise stated, Rest of Indonesia includes Bali, Musa Tenggara, Kalimantan, Maluku, Irian Jaya and East Timor. - 10 - Table 1.3t REGIONAL AREA AND POPULATION STATISTICS, SELECTED YEARS, 1971-1939 Rest of LS Java Sumatra Sulawesi Indonesia Area ('000 ki2) 132.2 473.5 189.3 1,124.4 X of total area 6.9 24.7 9.9 58.5 Population density (per/ke2) 1971 576 44 45 30 1980 690 59 55 38 1985 758 69 61 1988 812 79 66 46 Annual Pop. growth rates (S) 1961-71 1.9 2.9 1.9 2.3 1971-80 2.0 3.3 2.2 2.6 1980-85 1.8 3.1 2.1 2.5 1985-89 la Total (for area) and average (growth rates) for Bali, Nusa Tenggara, Kalimantan, Maluku, Irian Jaya and East Timor. Source: BPS. Table 1.9s REGIONAL DISTRIBUTION OF FARM SIZE Farm size (ha) Region c0.5 0.5-1.0 1.0-2.0 2.0-3.0 >3.0 Totals -________________________ (X) ------------------------- Java 57.4 24.8 12.2 2.7 2.9 100.0 Sumatra 28.8 26.7 26.4 9.0 9.1 100.0 Sulawesi 25.4 20.7 28.4 9.0 16.5 100.0 Rest of Indonesia 26.8 20.8 22.2 11.4 18.5 100.0 Indonesia 34.6 23.3 22.3 8.O 11.8 100.0 Source: BPS. for the remaining 15 percent of total GDP and 21 percent of agricultural GDP (Table 1.10). 1.23 Impacts on Food Crops. Regional shares of food crop production are presented in Volume II, Annex I, Table 1.6. In 1969, Java produced about 60 percent of paddy, 74 percent of corn, 76 percent of cassava, 79 percent of groundnuts, 49 percent of sweet potato and 86 percent of soybeans. While there were decreases in Java's share of production of palawija production (corn, cassava, groundnuts, soybeans and sweet potato) over the last two - 11 - Table 1.10: REGIONAL INPACTS OF GROWTH, 1979 - 1988 La (Z) Share of Total GDP Share of Aericultural GDP 1979 1982 1985 1988 1979 1982 1985 Java 51.6 54.0 54.9 54.4 54.6 53.0 55.6 Sumatra 28.1 27.0 27.8 28.1 21.1 24.0 23.7 Sulawesi 5.6 5.4 4.3 4.3 9.0 8.9 8.2 Rest of Indonesia 14.8 13.6 12.9 13.1 15.3 14.1 12.5 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 /a Data not available for earlier or more recent years. Source: Mission Estimates using BPS data. decades, its share of paddy production remained steady at about 60 percent. Sumatra is the second largest producer of all food crops, with the exception of sweet potatoes. The shares of palawija crop production have increased over the past two decades in all regions outside Java. 1.24 Expanded irrigation, more intensive input use, and the adoption of high yielding varieties all led to substantial increases in the production of rice and other palawija crops both on Java and the Outer Islands. Table 1.11 shows the decomposition of growth in paddy production according to cultivated area (extensification) and yield (intensification). Between 1979 - 1989, paddy production on Java grew on average by 4.7 percent per annum. The growth was due largely to more intensive production practices (para. 3.25). Yields increased by 3.0 percent per annum while area expanded by 1.7 percent per annum. 1.25 The major source of production growth in paddy on Sumatra, Sulawesi and the Rest of Indonesia, during the 1970s was also from yields (1.0 percent in Sumatra, 3.0 percent in Sulawesi and 4.2 percent in the Rest of Indonesia). This was also the case durivg 1979-89 as improved agricultural technologies became more widespread. Growth rates for production of palawija crops are indicated in Annex I, Table 1.7, Volume II. 1.26 Imnacts on Tree and Beverage Crops. The tree crops subsector occupies a strategic niche in Indonesian agriculture. The subsector provides a valuable source of foreign exchange earnings, employs a substantial portion of the agricultural labor force and generates incomes for millions of smallholder families. As primary raw materials for domestic industries, tree crop enterprises are essential in value-added activities as well as in the development of a domestic agro-industrial sector. The concentration of tree crops outside of Java is elso directly responsible for poverty alleviation in areas where poor soils are constraints to food crop production. The potential economic gains from tree and estate crop production and their roles in rural - 12 - Table 1.11: SOURCES OF GROWTH IN PADDY PRODUCTION, 1969-89 Average annual growth rates (Z) Paddv Drvland Paddy Wetland Paddy 1969-79 1979-89 1969-79 19;#)-89 1969-79 1979-89 Java: Area 0.7 1.4 -4.3 4.6 1.1 1.3 Yield 2.6 3.1 3.1 4.7 2.4 3.1 Production 3.4 4.7 -1.5 9.5 3.5 4.4 Sumatrat Area 0.5 2.4 2.3 -0.6 1.9 3.2 Yield 1.0 2.8 -3.3 2.9 1.6 2.4 7roduction 1.5 5.2 -1.0 2.3 3.5 5.6 Sulawesi: Area 1.8 2.7 -1.3 -6.5 2.4 3.7 Yield 3.0 3.7 0.7 2.7 2.9 3.2 Production 4.8 6.5 -0.6 -3.7 5.3 7.0 Rest of Indonesia: Area 1.5 0.6 1.0 -1.3 2.6 1.3 Yield 4.2 2.5 2.7 3.4 3.9 2.0 Production 5.8 3.1 1.7 2.1 6.5 3.3 Indonesig: Are-a 0.9 1.7 -2.2 0.0 1.6 1.9 ield 3. S 3 2.4 3.9 2.3 2.8 Productlion 4.3 -0.4 3.9 3.9 4.8 Note: Percentage change in area and yield may not exactly equal to changes in production due to rounding. Source: BPS and Mission estimates. poverty reduction have made this subsector the focus of substantial GOI and foreign investments (para. 4.16) 1.27 Rubber, coconut and oil palm contributed over 36 percent of total estate crop production and 5.4 percent of agricultural GDP in 1978 (Annex I, Table 1.8, Volume II). About 2.5 million jcbs vere provided by the subsector In 1978, Increasing to about 3.2 million in 1986. Between 1978-87, the production of the three major estate crops (rubber, coconuts and oil palm) grew by 3.4 percent per annum, while the production of all other estate crops - 13 - grew by 6.3 percent. Total estate crop. contributed 15.3 percent of agricultural GDP in 1978, increasing to 16.7 percent In 1987.6/ 1.28 Tea, cocoa and coffee are the three important beverage crops exported by Indonesia. Coffee exports wore subject to export quotas until the demise of the International Coffee Organization in 1989. The lifting of quotas in 19.9 resulted In a 20 percent increase in exports over 1988. Grade standards are still Imposed on coffee exports. Unlike coffee, international trade in cocoa has been unregulated, but restrictions remain on inter-island trade (paras. 5.79 and 5.80). These inter-island trade restrictions pose significant barriers since a majority of processing facilities are located on Java while a majority of cocoa growers are on the outer islands. For example, cocoa from southwest SulOasi is subject to a fee for port facilities on Java (a form of tax). Tea exports ar. a significant component of exports, accounting for 4.0 percent of value of agricultural exports during 1988-90 (Table 1.6). The value of tea exports increased by about 10 percent per annum between 1979/81 to 1984/86, at a time when the value of cocoa and coffee fell on the world market due to falling commodity prices. 1.29 The vulnerability of the sector to market and natural forces, as manifested by the recent drought, underscores the need for greater diversification within agriculture and towards non-agricultural activities, as the economy grows. The challenges and opportunities posed by new policies and strategies for guiding Indonesian agriculture after two decades of success are discussed in detail in subsequent sections of this report. 1.30 The report, however, does not address the issues (if any) and the strategies needed to foster *nhanced participation of productive labor, including women, in the economic activities. There is little quantitative data or evidence to substantiate what sociologists/anthropologists have observed i.e., that women In Indonesia have an adequate access to employment oportunities, inputs, support services, and compared to other countires, meet much less discrimination due to their gender. It may be useful for the government to explore the future role of women in agriculture, which is likely to increase. 6/ World Bank, Indonesiai Strategies for Sustained Development of Tree Crops. Report No. 7697-ID, December 7, 1989. - 14 - Box 1.L: WOMEN IN AGRICULTURE 1. Women account for a little more than 50 percent of the total population, and 70 percent live in rural areas. Almost two-thirds of rural women are members of low-income households. Female-headed households often belong to the poorest group. 2. Women play a crucial role in small-scale agriculture and fisheries, both as unpaid family labor and laborers. In rice cultivation, they are responsible for planting, weeding, harvesting and post-harvest activities. Home-gardens and small husbandry are also taken care of largely by women. With regard to cultivation of cash crops (coffee, cocoa), women predominate in harvesting and post-harvest activities. In small-scale fisheries, women play an important role in fish processing and marketing. Traditionally, women often are also the financial managers of rural households. 3. Employment of women has been adversely affected by the mechanization of harvesting and post-harvest operations in rice production, where mostly vomen were employed hitherto. Alternatively, intensification of rice production has increased the workload of female farmers. On balance, these were offseettig changes, and the employment of women actually increased because of their greater level of participation in activities such as horticulture, livestock and processing. Agricultural Intensification also made farmers more dependent on formal institutions for the supply of Inputs, technical information, and credit. 4. Women's access to agricultural extension services appears to be adequate. Unlike most other countries, a number of agricultural extension vorke's are females. Women's access to credit is limited not becanse of their gender but because of (a) the small size of loans; (b) targeted and subsidized credit that has led lenders to ration credit away from small borrowers generally (and these borrowers are perceived to be risky); and (c) other policies, such as the limit of one loan per household, which tends to direct loans to (land- owning) males. S. With regard to future stratexies, it is Important that: (a) socio-economic studies be carried out for the major subsectors to assess the present and potential role of women. This should Include a gender analysis related to information on differentials between women and men in formal education, vage levels and other income; and (b) activities be supported which have (i) direct benefit to vwmen, i.e., the income generating activities (vegetable growing, poultry raising, trading, food processing) and the Introduction of labor/time-saving devices; (iI) indirect benefit related to the strengthening of the organizational capacity of women, their involvement at the decision-making level and their capacity to increase their technical knowledge (formation of women's groups and/or representation on groups such as Water Users Associations, training); and (III) an impact directed at male farmers and Government staff as Intermediate target group (sensitizing them, for example, through discussions and gender analysis training). Sources: *Female Farmers from Invisible Workers to Active Participant.", a mimeo, Royal Netherlands Embassy, Jakarta, September 1991. ADB report on WID study, November 1989; World Bank Internal Discussion Paper on WID, April 1992. - 15 - II. EVOLVING FOOD DEMAND PATTERNS - DIVERSIFICATION 2.1 Overview. Demand projections for this section of the report are based on an assumed 6.0 percent per annum increase in real incomes over the next twenty years (projections under alternative growth assumptions are provided in the Appendix). With such an increase, real household incomes in Indonesia would more than double by year 2010. This is likely to cause a major transformation in Indonesian diets as those diets become more diversified and as consumers allocate an increasing proportion of their food expenditures to processed products, to livestock products, and to other foods such as fruits and vegetables. The analysis for Indonesia is based on a comparison with food demand patterns in six other Asian countries with equal or greater incomes. Given the importance of rice to the Indonesian economy, its future demand is examined in more detail and the results are compared with those in other studies. All the studies, including this report, project a significant slowdown in the increase in rice demand. Population growth will be the major factor affecting rice demand over the next two decades as income elasticities decline to zero and eventually turn negative. Trends in Food Consumption and Calorie Intake 2.2 Indonesia's food consumption patterns are fairly typical of those of other countries at an early stage of development but with rapid economic growth. As incomes rise, nutritional levels improve and diets become more diversified as consumers shift from traditional foods to "preferred foods" (with higher value-added and requiring greater processing). In the early stages of development, this transformation occurs mainly within the staple food category as preferred cereals, such as rice and wheat, replace "inferior" staples (low or negative income elasticity) in that diet. In Indonesia, the consumption of cereals continues to expand and cereals have partially replaced root crops in the average diet. The per capita consumption of cassava and sweet potatoes have declined during each of the past two decades (Table 2.1). Table 2.1: PER CAPITA HUMAN CONSUMPTION OF MAJOR FOODS Sweet Soy- Pea- Vege- Rice Maize Wheat Cassava Potatoes beans nuts Sugar Fruit tables Fish Meat -------------------------------------- kg/yr ----------------------------------------- 1968-70 99.7 20.0 3.4 70.1 18.4 3.3 2.1 6.9 26.2 16.7 10.0 3.4 1978-80 122.4 23.4 6.5 63.3 13.6 4.8 2.9 10.6 27.1 15.6 11.3 3.5 1986-88 141.7 29.8 9.8 54.3 11.3 7.4 3.0 13.6 34.1 21.4 14.1 5.8 -------------------------------- Growth Rates (S p.a.) ------------------------------ 19708 2.1 1.6 6.8 -1.0 -2.9 4.0 3.3 4.4 0.3 -0.7 1.2 0.2 1980. 1.9 3.1 5.3 -1.9 -2.3 5.5 0.5 3.2 2.9 4.0 2.8 6.7 Sources FAO Agrostat, 1992. _ 16 - 2.3 Within the cereals category, rice maintains its dominant position in Indonesian diets and per capita consumption continues to expand, although the elasticity with respect to income is declining (para. 2.17). Wheat is a preferred food and has grown the fastest, but from a very low base. Apparent consumption of corn is also increasing. However, this doubtless reflects the expanded use of corn for animal feed rather than for human consumption. According to the food consumption surveys (SUSENAS), the human consumption of corn has been declining over the past twenty years. In addition, cross- sectional income elasticities of corn demand from the annual surveys are negative. 2.4 With continued economic growth, the growth of cereal consumption can be expected to slow and eventually turn negative as diets become more diversified and as consumers shift to other preferred foods. In Indonesia, the evidence on this process is mixed. The share of cereals in total caloric intake has actually increased over the past decade (Table 2.2) and while the growth in the consumption of preferred foods such as meats, fish, fruits and vegetables is accelerating, these foods still account for a very small proportion of total calories consumed. Table 2.2: CALORIE INTAKE BY MAJOR FOOD GROUPS Meat Fruit Root Dairy Veg. Veg. I Year Total Cereals Crops Fish Pulses Oils Other Rice -C_________----------- CAL per person per day ---------------------- 1968-70 1,947 1,243 267 48 70 156 163 I 1,065 1978-80 2,341 1,542 198 56 74 277 194 I 1,317 1986-88 2t675 1,863 171 76 86 318 160 1,551 Share in Total Caloric Intake | 1968-70 63.9 13.7 2.5 3.6 8.0 8.4 54.7 1978-80 65.9 8.5 2.4 3.2 11.8 8.3 I 56.3 1986-88 69.7 6.4 2.9 3.2 11.9 6.0 5 58.0 Source: FAO Agrostat, 1992. 2.5 Consumers are also turning from traditional foods in their primary or semi-processed state to more highly processed products. The share of primary products in total food expenditures declined from 62 percent in 1980 to 57 percent in 1987. At the same time, the share of total food expenditure represented by highly processed products doubled from 11 to 20 percent (Table 2.3). This reflects increased consumption of prepared foods away from 17 - home as well as increased consumption of more highly processed products at home. The latter include prepared cereal products, canned products and processed meats. Table 2.3: SHARE OF FOOD EXPENDITURE BY PROCESSIdG LEVEL (in percent) Primary La Secondary /b Tertiary /c 1980 SUSENAS 62.0 27.0 11.0 1987 SUSERAS 57.0 23.0 20.0 /a Primary - rice, corn (fresh and dried), cassava (fresh and dried), fresh fish, fruits and vegetables. lb Secondary - flour, meats, sugar, milk, tempe, tahu, refined vegetable oil, spices. Ic Tertiary - bread, biscuits, processed dairy and meat products, canned products, processed meats, and prepared foods. ComDarisons With Other Countries 2.6 Comparisons of Indonesian consumption patterns with those in other Asian countries provide insights into the long-run patterns of food consumption. Countries in the region have a wide range of incomes and rice is still the major food staple in all countries. In Chart 2.1, average per capita calorie consumption from all foods and from cereals are plotted against average per capita income for seven Asian countries. Calories from all cereals are used because of the significant substitution that occurs between cereals. The seven countries are Indonesia, Thailand, the Philippines, Malaysia, South Korea, Singapore and Japan. Indonesia's 1986-88 caloric intake from all foods and from cereals are marked by points A and B, respectively, on the granh. 2.7 As incomes rise, total calorie intake from all foods reaches a maximum of about 2,850 Cal. per person per day. The three most advanced countries in the region, Korea, Singapore and Japan, now have calorie consumption in this range. Although 2,850 calories per day is well below the calories consumed in the Western industrialized countries, it is typical of the high-income Asian diet. While caloric intake may continue to increase, the increase is likely to be caused by changes in tastes rather than changes in income as these countries adopt more Western diets. 2.8 A striking aspect of Indonesia is that average calorie intake has reached 2,675 Cal. per person per day. This is exceptionally high given Indonesia's level of development. According to the Chart, countries which consume 2,675 Cal. per day typically have per capita incomes three to four times that of Indonesia. Another perspective is provided by comparing Indonesia with other countries included in the World DeveloDment Report 1990. CHART I GALORIE CQONSUMPTION VS INCOME AVERAGE FOR SEWN ASIAN COUNTRIES GAL PER PERSON PER DAY 25000 2000 B 16,001 ALL FOOt 1000 _ CEREALS S 500 t' 0 1000 2000 3000 4000 PER-CAPITA GDP (1985 U.S. DOLLARS) - 19 - The Report places Indonesla among the low income developing countries. Yet, Indonesia has the highest daily calorie supply of all low income countries and a higher daily calorie supply than many middle income countries. 2.9 Indonesia also appears exceptional in that there has been no apparent shift out of grains into other preferred foods. On average, the share of cereals in total calorie intake for the seven countries peaks at about 68 percent or 1,500 Cal. per day. Peak consumption occurs when per capita GDP reaches US$350 (1985 US dollars).7/ Total calories continue to increase at all income levels. Thus, the percentage of cereals in the total diet is declining for incomes above US$350. In 1986-88, Indonesia's per capita GDP was about US$560. Yet, the calories available from cereals were well in excess of 1,500 and the share of cereals in total calories consumed has continued to expand. 2.10 It is likely that data problems are at least partially responsible for the relatively high calorie consumption in Indonesia. However, it is also possible that structural characteristics and/or economic factors may also affect consumption. These include the degree of urbanization, the amount of rice and other foods entering commercial marketing channels, income distribution, and relative prices. Of these variables, only urbanization and relative prices are typically included in Indonesian demand studies. FAO, for example, found that Indonesia was unique among Asian countries in that it was the only country in which urban rice consumption exceeded rural consumption. In recent years, however, the opposite has been true. 2.11 Chart 2.2 provides insights on Indonesia's consumption of other food products relative to other higher income Asian countries. The consumption of meats, fruits, and vegetables is relatively low in Indonesia compared with these countries. Although the share of total calories from root crops declined by half over the past twenty years, the consumption of root crops is still well above that in other countries. The share of oilseeds is also relatively high. Oilseeds include scvbeans and peanuts which often are a traditional protein source in less developed countries. As incomes rise during the early stages of economic development, meats replace these foods as a protein source. However, oilseeds are also used in a variety of processed f ds. At later stages of economic development, per capita consumption of oilseeds tends to increase with incomes. Determinants of Future Food Demand 2.12 The major factors affecting food demand are population growth, income growth and its distribution, prices, and other socio-economic characteristics of the population. 7/ Cereals become an inferior good at about US$950. SHARE OF VARIOUS FOODS IN TOTAL CALORIES CONSUMED U INDONESIA [ THALAND C MALAYSIA 1 KOREA so | 0 O JAPAN 400 20 CEREALS ROOTS OILSEEDS MSTS FR & VEG SUGAR ORER CEREALS ROOTS OILSEEDS MEATS FR & VEG SUGAR OTHER - 21 _ DemograpihiA Factors 2.13 Indonesia's population growth has begun to slow and a further deceleration is expected during the next two decades. The Central Bureau of Census (BPS) estimates that the population growth rate fell from 2.4 percent per annum during the 19709 to 2.1 percent in the late 1980s (Table 2.4). BPS projects a 1.4 percent per annum population increase at the beginning of the next century. Even so, population growth will be a major factor affecting demand over the next two decades. Over a ten-year period, each tenth of a percent increase in population adds about 300,000 t annually to total rice demand at current per capita consumption levels. Table 2.4: DEMOGRAPHIC TRENDS Population Population Share in (BPS) (FAO) Share Age Group end year mid year Urban (15-44) --------- million ---------- -------- percent ------- 1961 97.1 98.1 n.a. 44.1 1971 119.2 123.2 17.3 42.5 1980 147.5 150.9 22.4 43.4 1985 164.6 166.5 26.2 44.1 1990 182.6 180.5 30.9 46.3 1995 199.6 194.8 n.a. 48.3 2000 216.1 208.3 n.a. n.a. 2005 231.4 220.6 n.a. n.a. 2010 n.a. 231.9 n.a. n.a. Growth Rate Percent per annum 1961-71 2.1 2.6 1971-80 2.4 2.3 1980-85 2.2 2.0 1985-90 2.1 1.6 1990-95 1.8 1.5 1995-00 1.6 1.4 2000-05 1.4 1.2 2005-10 n.a. 1.0 Sources: BPS aud PAO Agrostat. Population estimates for 1990 and beyond do not reflect the 1990 census. 2.14 United Nations population estimates for Indonesia present a different profile of the changing population. The population increase in the 1960. is estimated to have been much higher than BPS estimates. However, the deceleration in population growth is also occurring at a faster pace, and by - 22 - the year 2010, the UN estimates that the population growth rate will decline to about 1.0 percent per annum. This is a much lower estimate than the BPS estimates. 2.15 As population growth slows, the age composition c^! the population also changes. Since the early seventies, the proportion of the Indonesian population between the ages 15 to 44 has been increasing (Table 2.4). According to BPS forecasts, this trend r.s likely to continue into the next century. Because adults in this age group have higher nutritional needs than children or older persons, the aging of the population increases the amount of food needed just to maintain the nutritional status of a givin population. 2.16 In addition to population growth and age composition, other demographic factors may impatct food demand. For example, the trend toward urbanization in Indonesia is accelerating such that by 1990, 30 percent of the population lived in urban areas. More sedentary urban life-styles could lessen the demand for food and according to the past three SUSENAS surveys, per capita daily calorie intake in urban areas was 140 to 180 calories (7.5 to 10 percent) less than that in rural areas. Of course, other factors affect calorie consumption and the difference between urban and rural calorie intake does not reflect lifestyles alone. For example, SUSENAS is more likely to underestimate calorie intake in urban areas because of greater urban consur.ption of prepared foods, which is not fully captured in the survey. Income and Income Distribution 2.17 After demographic factors, the next most important determinants of food consumption are likely to be income growth and its distribution across regions and the population. Although income growth has undoubtedly played an important role in determining past demand for food staples, income elasticities of demand are declining in Indonesia. For the projections in this report (Table 2.6), the income elasticity of demand for rice falls to zero by the year 2000 and alternative economic growth assumptions have almost no impact on rice projections. In the future, therefore, income growth will likely have less impact on the demand for staples and more impact on the demand for other foods, the composition of food demand and the degree of processing. 2.18 Because income elasticities of demand are much higher for low income consumers, income growth that favors low income consumers or regions could alter the projected demand for staples. Gini coefficients for both urban and rural areas have fallen during the past four SUSENAS Rounds (Table 2.5). In addition, studies of Indonesian food demand indicate that elasticities for food staples are higher in rural areas. This in itself may be due to low rural incomes. Consequently, growth that is concentrated in rural areas will also improve the distribution of income and raise effective expenditure elasticities for the country as a whole. According to SUSENAS, the growth in per capita urban incomes has tended to exceed that in rural areas over the past two decades, but the difference between the growth rates has been small in recent years (Table 2.5). Consequently, the projections in this report do not explicitly take into account changes in income distribution. - 23 TIblo 25.t AVERAGE PER CAPITA EXPENDITURES'S IN URBAN AND RURAL AREAS 1970 1976 1978 1980 1981 1984 1987 Urban Food (Rp/mo) 1,293 4,358 5,226 7,305 8,898 13,632 17,494 Non-food (Rp/mo) 525 2,535 3,996 4,903 7,917 11,365 15,919 Total (R2/mo) 1.818 6.893 9.222 12.208 16.815 25.197 33.413 Gini coefficient n.a. n.a. n.a. 0.36 0.33 0.32 0.32 Food share 71.1 63.2 56.7 59.8 52 9 54.1 52.4 Cereals share 35.3 30.8 26.9 26.3 26.3 22.1 17.9 Prep. food share 6.9 8.3 11.2 11.0 8.1 14.6 16.6 Rural Food (Rp/mo) 1,006 3,065 3,460 5,336 6,210 9,146 12,147 Non-food (Rp/mo) 266 870 1,274 1,876 3,188 4,197 5,926 Total (Ro/mo) 1.272 3.935 4.734 7.212 9.398 13.343 18.073 Gini coefficient n.e. n.a. n.a. 0.31 0.29 0.28 0.26 Food share 79.1 77.9 73.1 74.0 66.1 68.5 67.2 Cereals share 42.2 43.4 39.9 37.7 37.1 34.5 32.4 Prep. food share 4.5 4.5 5.2 4.9 4.4 7.6 8.4 /a Nominal expenditures. Sourcess BPS. Prices 2.19 Wholesale rice prices in the Jakarta market have risen faster than both the &eneral price level and the prices for most other food items in recent years (Annex III, Table 3.3, Volume It). Therefore, the net impact of price changes on rice demand has probably been negative. However, price elasticities of demand, like income elasticities, have fallen over time. Recent estimates put the price elasticity of demand for rice in the neighborhood of -0.20. Barring dramatic changes in government price policy, therefore, price elasticities of demand, like income elasticities, are likely to decline in importance in determining future demand relative to demographics effects. - 24 - Table 2.6: DEMAND PROJECTIONS (FOOD AND FEED) /a 1988 1995 2000 2005 Baas yr. to to to to Year Units 1988 lb 1995 2000 2005 2010 1995 2000 2005 2010 -________ X p.a. -_______ Population Mlillon 175.6 199.7 216.1 231.4 246.1 1.9 1.6 1.4 1.2 Real PCE L Trillion Rp 64.9 97.6 130.6 174.7 233.8 6.0 6.0 6.0 6.0 Per cap. PCE US dollar J32.7 440.0 544.0 679.9 855.5 4.1 4.3 4.6 4.7 Cereals Indexed 100 118 129 137 142 2.4 1.8 1.3 0.8 Rice ' 000 t 26,075 30,836 33,725 35,881 37,228 2.4 1.8 1.2 0.7 Wheat ' 000 t 1,593 2,237 2,788 3,402 4,065 5.0 4.5 4.1 3.6 Corn ' 000 t 5,740 6,797 7,654 8,694 10,095 2.4 2.4 2.6 3.0 Food ' 000 t 4,725 5,157 5,307 5,296 5,145 1.3 0.6 0.0 -0.6 Feed 000 t 1,015 1,639 2,347 3,397 4,951 7.1 7.4 7.7 7.8 Root crops Indexed 100 100 99 95 90 0.1 -0.3 -0.7 -1.1 Cassava 9 000 t 11,555 11,558 11,567 11,332 10,902 0.0 0.0 -0.4 -0.8 Sweet pot. 9 000 t 1,900 1,701 1,565 1,403 1,232 -1.6 -1.7 -2.2 -2.6 Other Indexed 108 72 53 38 26 -5.6 -5.9 -6.6 -7.1 Sugar 9 000 t 2,201 3,171 1,052 5,102 6,326 5.4 5.0 4.7 4.4 Veg. oils Indexed 100 142 180 224 274 5.1 4.8 4.5 4.2 Oil crops IndeXed 100 124 146 172 204 3.1 3.3 3.4 3.5 Soybeans * 000 t 1,737 2,345 2,959 3,787 4,905 4.4 4.8 5.1 5.3 Food o 000 t 1,378 1,751 2,098 2,524 3,043 3.5 3.7 3.8 3.8 Feed 000 t 359 593 861 1,262 1,862 7.4 7.7 8.0 8.1 Pernuts ' 000 t 545 600 645 693 742 1.4 1.5 1.4 1.4 Other Indexed 100 126 150 179 214 3.3 3.5 3.6 3.6 Vegetables Indexed 100 128 154 187 228 3.6 3.8 3.9 4.0 Pulses Indexed 100 127 146 164 178 3.5 2.8 2.3 1.7 Fruit Indexed 100 145 195 267 370 5.5 6.1 6.5 6.8 meats Indexed 100 142 189 256 354 5.1 5.8 6.3 6.7 Pork * 000 t 106 153 202 268 354 5.4 5.7 5.8 5.8 Vill. poul. 0 000 t 98 139 181 237 309 5.1 5.4 5.5 5.4 Inten. poul. 9 000 t 99 186 300 491 806 9.4 10.0 10.4 10.4 Other Indexed 100 120 138 158 180 2.7 2.8 2.8 2.6 Milk ' 000 t 729 1,059 1,404 1,880 2,533 5.5 5.8 6.0 6.1 Eggs ' 000 t 385 610 832 1,117 1,475 6.8 6.4 6.1 5.7 Fish ' 000 t 2,218 3,148 4,000 5,030 6,250 5.1 4.9 4.7 4.4 Total Calories Indexed 100 121 137 3 170 2.8 2.5 2.2 2.1 a At real GDP and private consumption expenditure growth of 6 percent per annum. a Base year data are from BPS food balance sheets. Food use for corn and soybeans have been adjusted to reflect revised feed demand esthaates (Appendix A, Volume II). l Private Consumption Expenditure on GDP accounts in 1985 rupiah. Demand Towards Year 2010 2.20 Demand projections are based on a scenario of 6 percent per annum growth in real incomes and population projections from the BPS. According to BPS, the population increase id expected to be 1.9 percent per annum between 1988 and 1995 and fall gradually to 1.4 percent per annum between 2000 and 2005. A further deceleration of the growth rate to 1.2 percent per annum is assumed for 2005-2010. As a result, per capita real income growth rises slightly over the projection period--from 4.1 percent per annum between 1988 and 1995 to 4.8 percent per annum between 2005 and 2010. 2.21 The food demand projections are based on a statistical analysis of food consumption patterns in seven Asian countries (para. 2.6) at very - 25 - different stages of economic development (see Appendix B, Volume II). Calorie consumption curves are estimated for major food groups using cross-country data. Total calories within each food group are then allocated to individual commodities assuming a multi-stage decision process. 2.22 Under the base 6 percent growth scenario (Tables 2.6 and 2.7), the transition out of food staples will accelerate over the next two decades. The per capita consumption of grains is expected to peak towards the end of the current decade and decline thereafter. Within the staple food category, there will be a continued shift out of inferior staples, such as corn and root crops, into rice and wheat during the 1990s. ')uring the latter part of the 1990s and into next century, the per capita consumption of rice will decline and the decline in per capita corn consumption by humans will accelerate. 2.23 The growth in the per capita consumption of preferred foods, such as meats, fruits and vegetables, is expected to increase over the next two decades. Within the meats category, the largest increase will be in the consumption of intensively raised poultry, which will increase by a factor of ten over the twenty-year projection period. Pork consumption is limited by religious custom. Other meat consumption, primarily beef, is expected to increase very little. Typically, the demand for beef does not increase until a later stage of development. 2.24 In view of the rapid increase in the demand for intensively raised poultry, feed demand 8/ is projected to rise rapidly. Corn for feed use was about 20 percent of human use in 1988. By the year 2010, corn feed will about equal food demand. As a result, the growth of the total demand for corn, which drops slightly in the early 1990s because of declining food use, accelerates to over 3.0 percent per annum in the next century. 2.25 The pace of transformation of Indonesia's food demand depends on future economic growth. Under the base 6 percent scenario, the share of staples (grains and root crops) falls from 73 percent in 1988 to 59 percent in 2010 (Table 2.8). The share of animal products (all meats, eggs, fish and dairy products), fruits and vegetables rises from 4.6 percent in 1988 to 8.9 percent to 2010. The shift out of staples is far less under a 4 percent growth scenario and far more under a 7 percent scenario. The detailed tables for projected food and feed demand and calorie consumption under alternative growth scenarios of 4, 5, 7, and 8 percent are included in Annex IV, Tables 4.1 - 4.25, Volume II. 8/ The feed demand projections (Appendix A, Volume II) assume that the growth in livestock production matches the growth in demand for animal products. The projections are based on constant feed conversion ratee. This is a middle-of-the-road assumption. The growth in feed demand could be faster if transition towards more intensive feeding operations occurs at a faster pace in Indonesia. Intensive feeding operations, including those for ruminants, require grains for faster weight gain. On the other hand, improved feeding practices, improved animal husbandry, and better breeding animals will lead to more efficient feed conversion rates and lower growth in feed demand. - 26 - Tsble 2.7: PROJECTED PER CAPITA CALORIE FOOD CONSUMPTION /a Growth Rates 1988 1995 2000 2005 Base yr. to to to to Year 1988 lb 1995 2000 2005 2010 1995 2000 2005 2010 --- Calories per person per day - ---- Z p.a. ------- Cereals 1,784 1,849 19866 19855 19813 0.5 0.2 -0.1 -0.5 Rice 1,480 19539 1,555 1,545 1,508 0.6 0.2 -0.1 -0.5 Wheat 66 82 94 107 120 3.1 2.9 2.6 2.4 Maize 238 229 217 202 185 -0.6 -1.0 -1.4 -1.8 Root crops 185 163 148 133 119 -1.8 -1.9 -2.1 -2.3 Cassava 153 135 124 114 103 -1.8 -1.6 -1.8 -2.0 Sweet pot. 32 25 21 18 15 -3.4 -3.2 -3.5 -3.8 Other 6 4 2 2 1 -7.3 -7.4 -7.8 -8.2 Sugar 127 151 190 223 260 3.4 3.4 3.3 3.1 Veg. oils 191 239 279 324 374 3.2 3.2 3.1 2.9 Oil crops 258 281 306 338 376 1.2 1.7 2.0 2.2 Soybeans 86 96 105 120 135 1.6 2.1 2.4 2.5 Peanuts 39 38 38 38 38 -0.4 -0.1 0.0 0.2 Other 133 147 162 180 203 1.5 1.9 2.2 2.4 Vegetables 19 21 24 27 31 1.7 2.2 2.5 2.7 Pulses 19 21 23 24 24 1.6 1.2 0.9 0.5 Fruit 39 50 62 79 103 3.6 4.4 5.0 5.4 Meats 26 32 40 51 66 3.2 4.2 4.9 5.4 Pork 7 9 11 13 17 3.5 4.0 4.4 4.5 Vill. poultry 5 6 7 8 10 3.2 3.8 4.1 4.2 Inten. poultry 5 7 11 17 26 7.4 8.3 8.9 9.1 Other 10 11 11 12 13 0.8 1.2 1.4 1.3 Milk 7 9 11 14 17 3.6 4.1 4.6 4.8 Eggs 10 14 18 22 27 4.8 4.7 4.6 4.4 Fish 23 29 34 40 46 3.2 3.3 3.3 3.2 Total Cal. 2,688 2.870 2j9,9 3.129 3.256 0.9 0.9 0.8 0.8 La At real CDP and private consumption expenditure growth of 6 percent per annum. Lk Base year data are from BPS food balance sheets. Rice Demand - ComDarative Analyses (Various Studies) 2.26 Table 2.9 compares the projections for rice in the previous section with those of other recent studies on Indonesian food demand. The studies vary in terms of their base period data and projections period. In order to facilitate comparlsons, therefore, each projection was revised to a comparable - 27 - Table 2.8: SHARE OF MAJOR FOOD GROUPS IN TOTAL CALORIE INTAKE IN THE YEAR 2010 Commodity Group Share in total calorie intake 198-8 2010 Real Income Growth 4 percent 6 percent 7 percent Cereals & root crops 73.3 66.7 59.3 55.1 Animal products, fruits & veg. 4.6 6.4 8.9 10.6 Other 22.1 26.9 31.8 34.3 Source: Annex IV and Appendix B, Volume II. time period, 1988 to 2000, and was based on the same 1988 data. For each of the reconstructed projections, the projected growth rate for rice demand is the same as that in the original study.9/ 2.27 All the studies project a significant slowdown in the increase in rice demand. Compared with the 3.7 percent per annum increase of the 1980s, the projected increases over the next decade range from 1.6 to 2.8 percent per annum. The total projected increase in demand between 1988 and 2000 is from 5.4 to 10.2 million t. The most significant factor explaining demand i's population growth, which causes 58 to 100 percent of the total increase. The FAO uses the low UN population forecast for Indonesia and its demand projection from population growth is at least 0.5 million t less than that of other studies. The growth of demand due to income and/or other factors is generally small and varies from slightly negative to 4 million t. Both the FAO and CWFS use fairly high income elasticities of demand and project a 3.0 to 4.0 million increase in demand due to income growth. The projected increases are well under 3.0 million t. 2.28 This report estimates that the demand for rice will be around 33-34 million tons in the year 2000 and between 34-39 million tons in the year 2010 (Annex IV, Tables 4.1 - 4.25). With higher economic growth, the demand for rice in the year 2010 will actually be lower than under low growth scenarios because of a sharper decline in income elasticities of demand. OI Since some of the studies use a shorter projection period, Table 2.9 probably overestimates the projected increase in demand that would be obtained if the models used in these studies were simulated to the year 2000. - 28 - Table 2.9: COMPARISON OF RICE DEMAND PROJECTIONS Real Projected Due to Population income growth Demand Demand Net Due to Income and Source growth growth in demand 1988 2000 change population Other Factors ---2 p.a. ---------- ------------------- million m.t ------------------ IBRD (92) Base growth 1.8 6.0 2.2 26.1 33.7 7.7 6.0 1.6 High growth 1.8 7.0 2.1 26.1 33.3 7.3 6.0 1.2 Low growth 1.8 4.0 2.2 26.1 33.7 7.6 6.0 1.6 BAPPENAS Import parity 1.8 6.1 1.6 26.1 31.5 5.4 6.0 -0.6 Export parity 1.8 6.4 1.9 26.1 32.5 6.4 6.0 0,4 Ellis 2.0 4.5 2.6 26.1 35.3 9.2 7.0 2.3 PAO Neutral 1.6 3.5 2.5 26.1 35.1 9.0 5.5 3.5 Urban-Bi.s 1.6 3.5 2.4 26.1 34.6 8.5 5.5 3.0 Rural-Bias 1.6 3.5 2.6 26.1 35.6 9.5 5.5 4.0 IBRD (88) 2.0 3.6 2.5 26.1 35.1 9.0 7.0 2.0 Card-IOA 1.9 5.0 2.1 26.1 33.3 7.2 6.5 0.7 DGF-NOA 2.0 3.5 2.3 26.1 34.1 8.1 7.0 1.1 CWYS 1.9 4.3 2.8 26.1 36.3 10.2 6.7 3.6 Sourcest IBRD (92) a World Bank, Projections in this Report BAPPUNAS - Fletcher and Altemier BAPPERAS (1991). Import parity assumes rice prices at Import parlty. Export parlty assumes rice prices at export parity, approximately 30 percent below Import parity. Population growth Is assumed to be the same as in IBRD (92). PAO - Food and Agriculture Organization of the UK (1991). Ellis - Ellis (1968) based on high income growth scenario. IBRD (88) - World Bank (1988) CARD-W&A a Center for Agriculture and Rural Development, Iowa State, and the Indonesian ministry of Agrlculture (1990). DGF-NOA * Indonesia, Directorate General of Foodcrops, Ministry of Agriculture (1988). CWFS a Keyser and van Veen, Center for World Food Studies (1Q90). A population growth rate of 1.65 percent per annum between 1993 and 2000 lo assumed for the reconstructed projection. - 29 - III. CHANGING SUPPLY PROSPECTS AND CHALLENGES - MULTIULE SOURCES OF GROWH 3.1 Overview. This chapter evaluates supply prospects for rice and other commodities through year 2010. The intention is not to construct commodity balances but to indicate that diversification is occurring and will continue as an outcome of not only differential rate of growth of demand (previous chapter) but also of technical change. This is best left as a market-driven process. Given the uncertainties of the future course of the world economy and the associated price movements, it is argued that a flexible agricultural sector is needed, which can respond to the opportunities presented by changes in world market and prices, as they occur. In view of a long projection period (2 decades), it is also not considered appropriate to rely on econometrically estimated past trends in supply. Instead, reliance is upon agronomic experience, judgments of plant scientists concerning what improvements are on the shelf and what new varieties are likely to be forthcoming, and upon changes in the resource base. Agricultural diversification will be towards products of (a) high income elasticities and (b) high land use intensity (economizing in a scarce resource). These notably are horticulture, fisheries and small (poultry, in particular) livestock products. Grains, particularly rice and corn, will continue to dominate, although rice will not be a prime mover of the sector or of the increased value-added activities. But the prospects of retaining self-sufficiency in rice, as a result of continued yield gains through new varieties and hybrids, are good. Land and Water Resources 3.2 Present Land Use and ComDeting Demands. Indonesia combines one of the most densely populated areas of the world (Java) with large areas of some of the least populated areas of non-desert terrain (in the outer islands). There is, therefore, no overall land constraint upon the development of agriculture. The population density of Java is about 8 people per ha of total land, more than ten times the density of Sumatra and Sulawesi, and about 40 times the density of the rest of Indonesia (Table 3.1). Consequently, there are local constraints posed by land availability and competing uses for it, particularly in Java, which has 60 percent of Indonesia's people but only 7 percent of its land. 3.3 Competition for land is acute in Java because: (a) the population density is so high; (b) rice yields on sawah land are much higher than elsewhere in Indonesia, reflecting better soils, a long history of irrigation investment, and the development of intensive farming methods; and (c) demands for land for urban as well as for manufacturing development and infrastructure are much greater on Java than elsewhere in Indonesia. Demand for non- agricultural land is particularly strong on the northern coastal strip of the island, the location of some of Indonesia's most productive paddy land. 3.4 The area of land potentially available for paddy production is the outcome of four main processes. First, paddy land is susceptible to encroachment for urban land use and for infrastructure development. Second, an expanding number of farm families In rural areas require new land for house plots. Some of this will inevitably be paddy land. Third, there is - 30 - Table 3.1t LAND USE IN INDONESIA (AVERAGE O 1984-90) (million ha) Rest of _Java Sumatra Sulavesl Indonesia Indonesia Land use Type ha Z ha S ha X ha S ha X Forest 1.2 9.1 23.3 49.1 11.3 60.5 83.9 75.2 119.7 62.7 Bush/Scrub 1.4 11.0 7.7 16.2 2.2 11.7 7.4 6.6 18.9 9.9 Grasslend 0.1 0.5 2.8 5.8 1.1 6.0 6.3 5.7 10.3 5.4 Shifting Cultivation 0.3 2.2 3.4 7.2 0.5 2.8 7.5 6.7 11.7 6.1 Upland 2.3 17.3 1.7 3.6 0.8 4.1 0.5 0.0 5.3 2.8 Wetlands 3.4 25.6 2.2 4.5 0.8 4.5 1.5 1.3 7.7 4.0 Tree Crops 2.4 18.0 3.5 7.5 0.8 4.2 1.2 1.1 7.6 4.0 Urban Areas 1.8 13.5 1.4 2.9 0.3 1.6 0.3 0.2 3.8 2.0 Other 0.5 3.8 1.6 3.2 0.8 4.6 3.1 2.8 6.0 2.7 Total 13.3 100.0 AL-` 100.0 18.6 100.0 11.5 100.0 190.9 100.0 Land distribution (Z) 7.0 24.9 9.7 58.4 100.0 Population distribution (X) 60.0 20.3 7.0 12.7 100.0 Population density (people per ha) 8.1 0.8 0.7 0.2 0.9 Sourcess BPS; RePPProT (1990) The Land Resources of Indonesia. competition in land use from other crops. In this connection, the higher returns per hectare from rice than from palavija crops (in the irrigated/ wetlands) means that, at any likely set of relative prices, competition from other field crops is negligible. Sugarcane is an exception, where public authorities have made cane growing mandatory for farms in the vicinity of sugar mills. This policy has now been changed and the affected paddy land is expected to revert to paddy production. Some horticultural crops, however, can produce very high returns per hectare, and some diversion of paddy land to horticulture must be expected. Fourth, the area of paddy land, and particularly of high-yielding irrigated land, can be increased by investment in irrigation. The impact of each of these processes is estimated in the following paragraphs. 3.5 Potential Loss of Paddy Land to Other Uses and Other Crogs. There are no firm estimates of the extent of the annual transfer of paddy land to other uses, although the reality of urban and manufacturing expansion into paddy areas is immediately apparent in urban vicinities. A wide range of estimates of rates of transfer, from the implausibly low to the alarmist high, prevail. In this report, it is assumed that 13 percent of Java's 3.4 million ha of wetland (irrigated) in 1988 might be transferred out of paddy production - 31 - by the year 2010.10/ This is a very rough estimate, given the lack of adeqaate data. In addition, it is based upon estimates of past land transfers to non-rural u&es. Future transfere could be greater under a more efficient and deregulated land market. 3.6 In addition, there are possible shifts of land within agriculture, away from paddy towards horticultural crops for example. Incremental rural demand for fruits and vegetables has already been accounted for in the previous paragraph. The 13 percent loss of Java's wetland includee land transferred out of paddy for house compounds for an expanding rural population. However, additional land may be needed to meet the fruit and vegetable demands of the urban population. This report estimates that by the year 2010, 48,000 ha of wetland may be lost to fruit and vegetable production IO/ This estimate is based upon the following assumptions. One-half of the annual land requirements on Java for urban and industrial use (15,000 ha) and for infrastructure (25,000 ha) are likely to be met from sawah land, leading to a loss of 440,000 ha through 2010. In addition, requirements for houseplots in rural areas are expected to continue to increase, requiring a total of 150,000 ha over the period of which 100,000 ha (two- thirds) is paddy land. The assumed proportion of transferred land which is sawah is higher for rural houseolots than for general urban use, manufacturing and roads, because tne bulk of the rural population is located in sawah areas. These losses should be adjusted by adding back 150,000 ha of sawah currently required to be used for sugar cane production, the release of which has already been announced. The net losses are then 390,000 ha, oi. about 13 percent of the total. - 32 - for the urban population on Java.1/ This is equivalent to 1.4 percent of wetland area in Java. If at the extreme, Java also meets the increased horticulture demand of all of urban Indonesia, the diversion of paddy land on Java would likely be 138,000 ha, or about 4 percent of the total. 3.7 Possible Limits on Irrigated Paddy Land in Java. Increases in cropping intensity and yields (discussed in paras. 3.25-3.29), and continued expansion of irrigated land will offset paddy land losses. Estimates of long- term trends in land-use in Java (and Madura) over the past century are presented in Table 3.2. There was a steady expansion of arable land on Java and Madura from 1880 to about 1955. Since 1955, however, this trend has been reversed. Land use for gardens and compounds, has steadily increased with population growth for over a century. Total land under irrigation increased over the 75 years from 1880 to about 1955, and plateaued subsequently. Within the constant total area after 1955, technical irrigation systems have replaced non-technical systems. Overall, the long-term trends point to a land constraint on further agricultural expansion. 3.8 This conclusion is reinforced by estimates on land suitable and available for irrigation development (Table 3.3). Irrigation systems on land categorized as "fully suitable" can be developed at relatively low cost compared with land classified "conditionally suitable" . For present purposes, it suffices to note that only 0.003 million ha of new land on Java (together with Bali) are fully suitable for development of irrigation. In addition, there are some areas within existing irrigation schemes which have not yet been irrigated. Much of the upstream headwork investment cost has Ij/ These estimates are based on the USAID study on Agribusiness Development (With Emphasis on Horticulture). See Table Below. Calculations of Horticulture Land Requirements (Java. Urban Demand) Urban Consumption Yield/halvear Area Reaulred Additional Area ('000 t) t/ha ('000 ha) 1988 La 2010 Lk 1988 LI 2010 id 1988 2010 Required ('000 ha) Vegetables 1,067 2,657 10.1 15.6 106 170 64 Fruit 1,142 3,323 7.5 11.6 152 286 134 L/ Consumption in 1988 was 30.84 and 33.02 kg/cap/year for vegetables and fruit, respectively. The urban population on Java was 34.59 million. lb Based on the demand projections presented in Chapter II, the lcrease In per capita demand over the periods 1988 to 1995, 1995 to 2000, and 2000 to 2010 was 0.45, 0.50, and 0.59 percent per year for vegetables and 1.25, 1.5 and 1.79 percent per year for fruit. Urban population growth (for all urban centers In Java) vas asumed to be 5 percent per annum over the whole period. L For vegetables, following the UsAID study cited in the text, the sea.onal yield was assumed to be 4.4 t/ha and the cropping intensity 230 percent. LA The yields were projected to increase by 2 percent per annum over the period. Following the "worst case" scenario of the USAID study, as much as 75 percent of the diverted vegetable land is assumed to be wetland paddy (48,000 ha), and 25 percent to be rainfed rice (16,000 ha). For fruit, 30 percent was assumed to be grown on rainfed rice land (40,200 ha) and the remaining 70 percent on non-rice land. The total effect then is a diversion of 48,000 ha of wetland paddy and 56,200 ha of rainfed rice land. - 33 - Table 3.2: ARABLE LAND BY USE ON JAVA AND MADURA (million ha) 1880 1895 1910 1925 1940 1955 1970 1985 Irrigated (a) technical 0.04 0.08 0.32 0.63 1.31 1.42 1.47 1.86 (b) non-technical 2.31 2.68 2.53 2.57 2.07 2.03 2.03 1.59 Total 2.35 2.76 2.85 3.20 3.38 3.45 3.50 3.45 Gardens and compounds 0.71 0.91 1.12 1.30 1.26 1.30 1.47 1.59 Arable Upland 0.96 0.96 1.68 3.01 3.29 3.59 3.28 2.91 Estates 0.45 0.81 1.06 0.94 0.83 0.63 0.63 0.60 Total Arable Land 4.47 5.44 6.71 8.45 8.76 8.97 8.88 8.55 Source: P. van der Eng, "Growth and Productivity Change in Indonesian Agriculture, 1880-1985," Research Memorarndum 348, Institute of Economic Research, University of Groningen, 1990. already been incurred for this land, which represents the least-cost opportunities for expansion of irrigated paddy land, especially on Java (Potential I land). The DGWRD (Project BTA-155) has estimated that, on Java, there are about 47,000 ha of sawah land in irrigation schemes under canal command which have not yet been irrigated. In addition, there are 33,000 ha of non-sawah land under command which could also be bunded and irrigated (Potential 2 land). It is assumed that these works will be completed on a priority basis, adding about 80,000 ha to irrigated lowland on Java, but reducing the area of rainfed lowland by 47,000 ha. 3.9 Possible Limits on Irri,ated Paddy Land. Outside Java. While the constraints upon land expansion on Java are primarily physical (little or no new land remains for development), the constraints on land expansion off Java are mainly economic, social, and environmental. Almost 7 million ha of new land off Java has been identified by the Ministry of Public Works as suitable for irrigation development. Of this, almost 3 million ha are suitable at "low cost". In addition, there is about 400,000 ha of land off-Java which is within irrigation schemes but which is not yet irrigated. 3.10 Off-Java, therefore, the issue is not the physical availability of new land, but the cost of rehabilitation and of bringing new land under irrigation. These costs have increased sharply over the twenty years of the first four Repelitas. Real expenditures in constant 1975/76 Rupiahs, areas completed, and unit costs per area complezed during each of the Repelitas are indicated in Table 3.4. These data should be interpreted with caution. There are substantial lags in public works completed relative to expenditures which are only partially accounted for in Table 3.4 by the use of five-year periods rather than single years. There are alsc changes over time in design - 34 _ Table 3.3: POTENTIAL AVAILABILITY OF LAL. FOR WETLAND DEVELOPMENT (million ha) New Land /a Land Within Existing Fully Conditionally IrriRation Areas /b Suitable Suitable Potential 1 Potential 2 Total Java/Bali 0.003 0.507 0.047 0.033 0.590 Sumatra 0.607 1.028 0.070 0.158 1.863 Sulawesi 0.100 0.130 0.020 0.067 0.317 Irian Jaya 1.221 0.969 0.004 0.004 2.198 Other 0.783 1.491 0.025 0.048 2.347 Total 2.714 4.125 0.166 0.310 7.315 .La "New land" is defined as land outside the boundaries of existing irrigation schemes. No investments in irrigation infrastructure have yet been made with respect to this land. Suitability is defined in para. 3.8. b "Land within existing irrigation areas" is land within the boundaries which has not yet been brought under irrigation. "Potential 1" and "Potential 2" land are both under command of canals, but the former is sawah while the latter is non-sawah. In addition, there is about 0.4 million ha of Potential 3 land not shown in the table, which is not under canal command but within irrigation system boundaries. Sourcet Calculated from Bina Program Pengaran and Delft Hydraulico, Planninz of Integrated Water Resources Development, (Project BTA-155 Phase 1I), Jakarta, June 1991. The new land areas presented in the table have been adjusted downwards by the reduction factor used in the Ministry of Public Works study to allow for the fact that "experience shows that an average only 36 percent of the physically suitable area is included in the ultimate wetland development" (pages 2-12 of the Report cited above). standards and accounting conventions. Nevertheless, the trends are clear. The table shows rapid increases in the unit costs of new construction, rehabilitation, and river and flood control, but no clear trend for swamp/tidal land development. Increasing costs of irrigation development are, of course, to be expected. It is a rational strategy to develop the easiest, least-cost sites first, leaving more difficult sites until later.12/ 121 For reservoir-based irrigation schemes, this tendency is offset to some extent by heavy initial investment in storage capacity, followed by low unit cost expansion of the area under command. Most Indonesian schemes, however, are run-of-the-river schemes. - 35 - Table 3.4: TRENDS IN REAL COSTS OF IRRIGATION (Constant 1975/76 Rp) Tvpe of Development Rehabil- New Con- Swamp/ River and Period itation struction Tidal Flood Control Repelita I Real Exp. (Rp billion) 74 38 50 10 (1969-73) Area Completed ('000 ha) 954 191 179 289 Unit Cost.('000 Rp/ha) 77 200 280 34 Repelita II Real Exp. 139 186 50 208 (1974-78) Area 528 326 179 614 Unit Cost 263 470 280 339 Repelita III Real Exp. 263 358 55 237 (1979-83) Area 395 436 455 579 Unit Cost 667 821 120 410 Repelita IV Real Exp. 180 316 38 216 (1984-88) Area 152 198 120 256 Unit Cost 1.183 1.594 316 842 Source: Calculated from Mark W. Rosegrant and Effendi Pasandaran "Irrigation Investment in Indonesia: Trends and Determinants", IFPRI and CAER, Bogor, January 1990. 3.11 In evaluating the land base available for maintaining self- sufficiency in rice, it has been assumed in this report that high-cost irrigation expansion will not take place. Instead, the irrigated area expansion on both Java and the Outer Islands is assumed to be confined to not- yet-irrigated land under command in existing irrigated areas. On the outer islands, the DGWRD has estimated that there are 120,000 ha of Potential 1 land available. This is sawah land within canal command, but not yet irrigated. It is assumed that all this land is converted from rainfed lowland to irrigated lowland, as a high-priority, low cost investment. Drainage improvements in selected irrigated areas and private sector development of shallow tube wells, at modest costs, would also help maintain rice self- sufficiency. 3.12 It is Government policy to move sugar cane production on Java to off-Java. Without necessarily endorsing this policy, but in order to evaluate a conservative scenario for rice self-sufficiency, 150,000 ha of sawah land is assumed as not available for paddy off-Java in 2010. 3.13 The net effect of these changes is that the area of irrigated lowland is assumed to remain almost static off Java from 1988 to 2010, while - 36 - the area of rainfed lowland is projected to decline by about 11 percent. The area of upland paddy is projected to remain unchanged. 3.14 All the changes in land use, discussed in the text, are summarized in Table 3.5. The net loss of lowland irrigated land used for paddy production on Java is estimated to be about 317,000 ha or almost 13 percent of the total. In addition, there is a net loss of rainfed lowland of 184,000 ha, or almost 21 percent of the total. These reductions are conservative estimates and probably represent upper bounds on the likely land diversion from paddy production on Java. Table 3.5: LAND AVAILABLE FOR RICE PRODUCTION 1988 AND 2010 (million ha) Changes 1988 to 2010 Urban E b Investmnt Use for d Area J_ infr. Rural Lb Sugar. in /c Horti- Net Area Location Type 1988 structure houseplots cant lb irrigation culture los1 2010 Java Lovland Irrigated 2,523 -0.330 -0.074 +0.111 40.080 -0.104 -0.317 2.206 Lowland Rainfed 0.894 -0.110 -0.026 40.039 -0.047 -0.040 -0.184 0.710 Upland 0.516 - - - - -0.056 .0.056 0.460 0ff-Java Lowlaud Irrigated 1.792 - _ -0.111 +0 12C - 0.009 1.801 Lowland Rainfed 1.393 - - -0.039 -0.120 _ _0.159 1.234 Upland 2.162 - - - - - _ 2.162 jj Mission astimates boasd upon BPS and IWERD (BTA 155). 1k Based on estimates above in text. f For Java, 47,000 ha of unirrigated sawab land is assumd to cme under irrigation, adding that area to 'lowland irrigated" and subtracting it from "lowland rainfed". This it "Potential 1" land in DOMRD Report on Project BTA-155. In addition. 33,000 ba of Potential 2 land (non-saveh) is brought into *avab and irrigated. (See Table 5.4, p 8-7 of BTA-155 Report). For Off-Java, 120,000 ha of not-irrigated savab land already under canals (Potential I land) is seemed to be brought under Irrigation and thus added to "lowland irrigated", but subtracted from "lowland rainfed", (sam source). These are nigh priority, low coat investments. /d Calculated from assumptions in texts Java supples &11 the inerematal urban dand for horticultural crops. 3.15 It seems likely that more irrigated land off-Java will become available, although not at the same rate as in the past, because of sharply- increasing costs. During the next 5-year plan period, the expansion of new irrigated area (off-Java) could range from 35,000-50,000 ha per annum (para. 3.28). Increased reliance needs to be placed on improved management of rainfed sawah and existing irrigated areas. Water 3.16 There are three inter-related water issues which will be of increasing importance in the future. These are: the efficiency of water use, competitioni for limited supplies of water for non-agricultural use, and water quality. 3.17 Irrigation efficiency is conventionally defined as the percentage of water, released at the source, which is used in production. While larger schemes in Indonesia are designed to operate at 50 percent efficiency, most studies quote the actual efficiency achieved as being about 30 percent. Studies by IIMI (Table 3.6) show that the largest source of inefficiency is at the intake, attributed to lack of proper control structures and inadequate management. The efficiency at the farm level is usually relatively high, - 37 - ranging between 8 to 100 percent of the achievable. It should also be noted that low effic,hanaw was found not only during the wet season and with systems with plentiful wata supplies, where there would be little incentive to economise on water use, but also during the dry season and in systems with significant water shortages.13/ Table 3.6: IRRIGATION EFFICIENCY LEVELS (2) (Scheme - Specific) Maximum Indonesian Percentage of Level of Operations Achievable Level Achievable Intakes 90 20-70La 22-78 System Operations 70 45-65Lb 64-92 On-Farm Use 80 65-80Lb 81-100 Overall 50 6-36/c 11-72 la Based on IIMI Studies in East and Central Java. 1k Estimated, based on several World Bank appraisals, 1981-85. iL Average efficiency is about 25Z. Source: III Studies, 1987, quoted in Indonesia: Sustainable Develo2ment of Forests. Land. and Water, World Bank, 1990. 3.18 By increasing system efficiency to design standards (50 percent), present levels of effective use for irrigation can be maintained, while at the same time releasing water equivalent to 40 percent of present off-takes for other uses--either expanded irrigation or non-agricultural use.14/ In this way, the water requirements of Java, which will expand substantially in the future, and where there are limited opportunities for tapping into new water sources, can be met. The means by which water savings through efficiency increases will be achieved depend upon local conditions and opportunities. Timeliness and reliability of water delivery are important factors contributing to yield increases and facilitating crop diversification. Part of the solution lies in some upgrading of the systems and much improved O&M, financed by service charges on farmers and monitored by them, as in the recent World Bank-assisted irrigation projects. Basin-wide improvement in water I3/ Indonesiat Sustainable Development of Forests. Land and Water, (para. 4.27). 14/ At the present efficiency rate of 30 percent, only 30 units of water are available for irrigation from 100 units released. By improving efficiency to 50 percent, these same 30 units for irrigation can be supplied by releasing 60 units at the intake. This leaves 40 units grose, or 40 percent at the intake, which can be released for other uses. The net figure for other uses, after losses, would be less than 40 units. - 38 - conservation and management will be increasingly important, particularly in view of the evidence that water "wasted" or "lost" in one part of the system can only flow downstream or to underground aquifers. This only emphasizes the importance of basin-wide efficiency, as distinct from system efficiency. 3.19 At the present time, water shortages and comDetition for limited supplies is confined to some localities on Java and even then mainly in the dry season and/or in a drought year such as 1991. Projections of future water demand 15/ suggest that overall water needs through the year 2010 can be met provided that the use of water is managed much more effectively than at present. Elements of improved management include achieving hlgher efficiency in irrigation water distribution (by far the largest user of water), more effective and better-monitored O&M, management of water resources among competing users on a river basin basis, reducing water loss in municipal water systems and pricing municipal and industrial water from surface as well as groundwater sources. 3.20 While pricing irrigation witer on a volumetric basis represents a first-best solution to economizing water use at the farm level, such pricing requires controllable and measurable water supplies at the farm level. Given the small size of Java's farms and the fragmentation of plots, such a system is probably not feasible for the foreseeable future. Improving O&M, as referred to above, is an essential step. In addition, it is possible to develop effective surrogates for individual farm water metering by charging water user groups the wholesale cost of water at secondary outlets. The distribution of water among farmers and other users can be left to the groups. In the meantime, the collection of irrigation service fee on the area and crop basis, and the turnover of small echemes (less than 500 ha) to the water users associations, should be extended on a nationwide basis. 3.21 Competing demands for water between agricultural and non- agricultural users are not usually system-wide; instead they occur in particular locations such as around expanding urban areas or between alternative uses in rural areas, such as for aquaculture or for agro- processing industries. The productivity of water, as measured by the price nisers are willing to pay, is very much higher world-wide in non-agricultural usage than in agriculture. It is important, therefore, that non-agricultural use should have first claim on available supplies.16/ Except at particular localities and during the dry season, this should not pose a constraint on agricultural production. Projections of future water needs in Java indicate that non-agricultural demands will be no more than 10 percent of the total through 2010. Further, expanding urban activities reqtire both land and water; so that, to the extent urban expansion encroaches upon irrigated land, the transfer of land to urban use is simultaneously associated with the potential to transfer water also. In case the non-agricultural water demand becomes very high, particularly during the dry season and near the urban IS/ Carried out in Indonesia: Sustainable Development of Forests. Land. and Wator. 16/ This is already GOI policy in water-allocation regulations. - 39 - areas, a detailed review of water balance and an improved integrated water resource management in the metropolitan regions and basins will be needed. 3.22 The evidence to date suggests that agricultural activities are not a significant threat to water quality. After the banning of certain pesticides, studies have shown no significant pollution due to agricultural chemicals. Similarly, crop production is not so far adversely affected by the impact of polluted water supplies. This is not to say that water pollution is not a problem in Indonesia. It is a problem, particularly in some areas of Java, where water pollution by human and industrial waste is at acute levels. Also, the rural population is subject to health risk on account of unsafe drinking water supplies. 3.23 There are two water quality problems for agricultural production. First, fisheries and aquaculture are particularly susceptible to water pollution, especially on the industrializing north coast of Java. One solution to this problem may be to divert canal water to aquaculture (rather than the use of return flows), as is the practice in some areas. Another may be to further develop fishing and aquaculture activities off-Java. Coastal zone management is becoming a critical need. A second potentially more serious problem in the long-term, is the spread of agro-processing and other manufacturing activities to rural areas, particularly on Java. Such activities are an essential part of development, are very significant sources of higher incomes for farming families, and should be encouraged rather than hindered. However, they also can generate pollutants, particularly those discharged into the water supply in rural areas. The solution to these problems lies not in regulating the growth of the activities themselves, but in the regulatory and fiscal policies to control such effluents. However, these are issues which go well beyond the agricultural sector and are not developed further here. Sunn1V Prosnects for Rice and Other Commodities 3.24 Appendix I, Volume II, discusses the agronomic/technical considera- tions, including the need for sound crop rotations, improved management practices and varietal improvement programs, as needed for rice, corn, soybeans and sugarcane. Four different projection approaches are used, with varying degrees of reliance upon technical judgements on the one hand and upon statistical techniques on the other. Results from econometric models are available for most crops through 2000, but only for major export crops through 2010. The approaches used for estimating supply, including the uncertainties associated with the future world markets and prices, are discussed in Appendix C, Volume II. Rice 3.25 Scone for Intensification and Yield Improvements. Indonesia's introduction of high yielding (HY) rice varieties (starting with IR8), developed at IRRI at the onset of the green revolution, played a crucial role in achieving self-sufficiency since 1984. Yield increases in irrigated low land (wetland sawah) were due to availability of irrigation water, a proven technical package, supply of adequate inputs and 3OI commitment to rice self- sufficiency. Annual average yields are the highest in Java, followed by - 40 - Sulawesi, Sumatra and other islands. This pattern Is consistent with availability of physical and human resources and Is not expected to change in the foreseeable future. 3.26 Potential yield levels of present BY varieties and technology packages under Irrigated experimental conditions In Indonesia are reported to be about 8-10 t/ha per season with higher yields in the dry season. Some progressive farmers are already reporting yields of 7-8 t/ha. Thus, the yield levels assumed by year 2010 (Table 3.7) are conservative estimates. 3.27 The shifting of the rice yield frontiers beyond the present farmer and experiment station levels will probably come from four complementary avenuess (a) the development and adoption of hybrid rice under tropical conditions in the short- and medium-term future (next 10 years) with yield gains of 20-30 percent without additional lnputs; (b) the change in the architecture of the rice plant in the long-tern (10-15 years) by reducing the number of tillers from 20-25 (only 15 are productive) to 4-5 productive tillers but with larger panicles (250 grains) as compared to 100-120 grains per panicle of current varieties; (c) the further incorporation of peit resistance and other characteristics through continued crop improvement including new applications of biotechnology in the medium- and long-term to provide sustainability of yield of the newly developed varieties; and (d) the Improvement of crop management practices, i.e., direct seeding, increased plant populations, judicious use of pesticides In the context of IPM programs, better methods of fertilizer applications (deep placement) and use of slow- release formulas, incorporation of organic matter and leguminous crops to improve soil health and crop rotation. IRRI's rice research strategy emphasizes all these factors and has a goal of a rice yield of 15 t/ha. A primary factor will be the innovative translation of research results to the farmers' fields. Indonesia's track record of adopting rice technology generated through IRRI is commendable and this trend is assumed to continue. 3.28 Estimates of the potential for expanding the production of rice are based upon the land resources presented in Table 3.5 and the prospects for intensification and yield increases are sumaarized in Table 3.7. The land potentially available for rice is summarised In the top section of the table. It may be noted that the area of most land typos is expected to decline or, at best, not increase above the 1988 levels.j2J Off-Java, there is considerable additional scope for furthr- expansion, although at high investment cost per hectare. Modest increases ln cropping intensity (about one half of one percent per annum) are projected for Java, based primarily upon improved water management practices in the irrigation systems. Off-Java, some catching-up with Java is expected, as more experience is gained in system operations and as investments are made iin lproved control structures. By 2010, the cropping intensity on irrigated lowland Off-Java, for example, is 17/ This does not imply that no new irrigation investment is projected. On the contrary, the areas in the table represent the net area available for rice after many other demands on rice land have been met. Furthermore, since the newer varieties, hybrids etc. will take longer time to develop and disseminate, annual irrigation expansion could be required on some 35,000-50,000, during the next plan period. - 41 - Table 3 7: POTENTIAL FOR RICE PRODUCTION 2 p.a. 19881a 1995 2000 2010 change Area Java Irrigated lowland 2.52 2.40 2.36 2.21 -0.6 (million ha) Rainfed lowland 0.89 0.84 0.80 0.71 -1.0 Upland 0.52 0.51 0.49 0.46 -0.6 Off-Java Irrigated lowland 1.79 1.79 1.80 1.80 0.0 Rainfed lowland 1.39 1.30 1.31 1.23 -0.6 Upland 2.16 2.16 2.16 2.16 0.0 Cropping Java Irrigated lowland 1.70 1.75 1.80 1.90 0.5 Intensity Rainfed lowland 0.85 0.87 0.90 0.95 0.5 Upland 0.70 0.75 0.80 0.80 0.6 Off-Java Irrigated lowland 1.15 1.32 1.50 1.70 1.8 Rainfed lowland 0.74 0.77 0.80 0.85 0.6 Upland 0.40 0.50 0.60 0.70 2.6 Yield Java Irrigated lowland 5.40 5.70 6.20 7.00 1.2 (t/ha) Rainfed lowland 3.60 3.90 4.30 5.0 1.5 Upland 2.30 2.40 2.60 3.00 1.2 Off-Java Irrigated lowland 4.70 5.00 5.40 6.20 1.3 Rainfed lowland 2.50 2.80 3.30 3.60 1.7 Upland 1.80 2.00 2.20 2.40 1.3 Produc- Java Irrigated lowland 23.1 23.9 26.3 29.4 1.1 tion Rainfed lowland 2.7 2.9 3.1 3.4 1.0 (million tons) Upland 0.8 0.9 1.0 1.1 1.5 Total Java 26.6 27.7 30.4 33,9 1.1 Off-Java Irrigated lowland 9.7 11.8 14.6 19.0 3.1 Rainfed lowland 2.6 2.8 3.5 3.8 1.7 Upland 1.6 2.2 2.9 3.6 3.8 Total Off-Java 13.9 168 21 .0 26.4 3 Total Indonesia 40.5 44.5 51.4 LAA 1 la For production, 1988 figure is the average of 5 years centered on 1988. Source: BPS, DGWRD: BTA 155 Report, Mission Estimates. projected to reach the same level as on Java in 1988. This implies an average annual rate of increase of 1.8 percent. Similarly, the cropping intensity on rainfed lowland and upland rice is expected to catch up to the 1988 Java level by 2010. Throughout Indonesia, the largest single contribution to increases - 42 - in rice production is expected to be higher yields, mainly from improved cultivation and crop management practices in the early years, from the development of high yielding pest-resistant new varieties, introduction of hybrid rice and of the architecturally innovative varieties in the later years (see Appendix I, Volume II). 3.29 The net outcome of these various factors is included in Table 3.7 and summarized in Table 3.8. Rice production is expected to grow by 1.1 percent per annum on Java and 3.0 percent per annum Off-Java, resulting in a 1.8 percent increase for Indonesia as a whole. Correspondingly, the importance of Off-Java in total rice production is expected to increase: its share riees from 34 percent of the total in 1988 to 44 percent in 2010 (Table 3.8). Table 3.8: SUMMARY OF PADDY AND RICE PRODUCTION POTENTIAL (million tons and (percent)] 1988 /a 1995 2000 2010 Total Paddy Production 40.5 (100) 44.5 (100) 51.4 100) 60.3 (100) Java 26.6 (66) 27.7 (62) 30.4 (59) 33.9 (56) Off-Java 13.9 (34) 16.8 (38) 21.0 (41) 26.4 (44) Milled Rice Production /b 27.5 30.3 35.0 41.0 Demand 26.1 30.8 33.7 37.2 Safety Margin Le 1.05 0.98 1.04 1.10 /a Production in 1988 is the average of five years centered on 1988, used as the base year for projections. lb Converted from paddy at 0.68. Le The "safety margin" is a ratio of production ;o, demand. This could be slightly lower if the provisions are made for waste or seed. 3.30 It is anticipated that Indonesia can maintain trend self-sufficiency in rice without resorting to a more protectionist price policy (paras. 5.26- 5.30). Rice production is projected to equal or exceed domestic demand in all years with a growing safety margin (Table 3.8). Although shortfalls necessitating imports may occasionally occur in drought years before 2000, there will be some potential safety margin in the next decade. In addition, reductions of post-harvest losses during threshing and milling could increase further the amount of safety margin. This does not imply that Indonesia will become a major exporter of rice. First, while Indonesia is an efficient -43- import-replacer of rice, its production costs are relatively high when compared to those of competitors and it does not presently have a significant yield gap relative to competitors.18/ The projected production increases are based largely on yield increases from the introduction and adoption of new varieties. Although these new varieties may result in reducing per-unit coats, they will also be available to Indonesia's competitors in world markets, and may not confer a competitive edge on Indonesia's exports. 3.31 In the event that the rice demand and supply projections do not materialize and rice deficits develop, greater attention will be needed tot (a) deregulating imports of other staples, such as wheat; (b) maintaining the national reserve stock of rice held by BULOG which is important for food security; *(c) continuing investment in research in new cultivars such as hybridas, and in programs such as the Integrated Pest Management; and (d) completing existing command areas of surface irrigation, and realizing the private sector groundwater development potential, particularly in Java, in the rainfed areas as well as a source of supplemental irrigation in dry seasons. 3.32 There are concerns within the Government that transfer of land out of paddy production for urban and other purposes could occur at a sufficiently high rate as to undermine the objective of maintaining self-sufficiency in rice. Primarily for this reason, regulations are being introduced which severely restrict the transfer of paddy land (sawah) to non-agricultural uses. These regulations are expected to be incorporated into legislation before the end of 1992. This proposed attempt to regulate land transfers raises many issues, such as Industrialization and urbanization policy, which are outside the purview of agriculture, but more general implications of such policies are discussed in para. 6.19. Likewise, the implications of the Government's plans to get large, private commercial firms to establish rice plantations, are also discussed in para. 7.21. Box 4.3 elaborates on some of the drawbacks of the current land policies, and the adjustments required. Corn 3.33 Scope for Intensification and Yield Improvements. In 1990, some 5.5 million tons of corn were produced with an average of 1.95 ton/ha, primarily due to the introduction of high yielding open-pollinated varieties (e.g., Arjuna) and hybrids and a modest increase in the area harvested. About 75 percent of Indonesia's corn is grown on Java and Madura, about 15 percent in South Sulawesi and Nusa Tenggara Timur, and the remaining 10 percent in other areas. Corn is grown on diverse types of soil, from lowland alluvials to upland volcanic soils and from rich sawah soils on Java to leached hillside laterites on other islands. More than 70 percent of the crop is planted in 18/ Unlike for corn, for example, where there is a significant yield gap between Indonesia and its competitors. - 44 - upland areas and under rainfed conditions, and about 40 percent is planted in monoculture. Since differences in natural fertility and soil management practices greatly affect the agronomics and economics of corn production between areas, there is an increased need for effective regional experimentation and extension programs to tailor production recomendations to local conditions. 3.34 Yellow corn occupies about 65 percent of the corn area and white corn, the balance. Rscent increased yield levels have been primarily for yellow corn using improved varieties, eag., Arjuna and Hybrid C-1. Research has concentrated on yellow corn in view of its multiple uses in human consumption, animal feed and industry and the expected growth in demand. White corn is mainly grown in central Java for human consumption and the noodle industry. While demand for white corn is not expected to increase appreciably, high yielding varieties should nevertheless be developed to economize on utilization of potentially scarce land. 3.35 Substantial growth in corn production is expected over the next two decade., based on a slight expansion of area on Java, higher growth of area on the Outer Islands (particularly Sumatra) and significant yield growth Indonesia-wide. There are four main reasons to expect a rapid growth of corn production, to the point Indonesia could emerge as a corn exporter. First, studies of international competitiveness show that Indonesia has, or is near to having, a competitive advantage as an exporter of corn.l9/ Second, there has been a sustained growth of production from 1970 to 1990 of over 4 percent per year, based on both production and yield increases. Production has steadily shifted away from Java, particularly to Sumatra, and further area expansion is expected. Third, although yields have increased by almost 3 percent a year, they are still very low by international standards. There is, therefore, considerable scope for Indonesia to increase yields just bys (a) Off-Java "catching up" with Java; and (b) Indonesia "catching up" with other Asian countries. There is also scope for the introduction of new higher yielding varieties during the next two decades. The technical basis for these judgements la presented in para. 3.33 and in Appendix I, Volume II. Fourth, less competition for land is expected from other crops, because Indonesia is projected to achieve a safety margin for self-sufficiency in rice, soybean production is expected to increase slowly (para. 3.40), and the area under sugarcane production may well decline (para. 3.46) 3.36 From 1988 to 2010, production is projected to expand by about 3.5 percent per annum, made up of an annual average yield increase of about 3 percent and an area increase of about 0.5 percent. Although total domestic demand Is expected to grow at 2.4 percent per annum until year 2000 and about 3.0 percent thereafter, Indonesia could still have substantial quantities available for net exports, almost 2.5 million tons, by 2010. The exportable surplus would, however, be much less if the corn use in feed is higher than that suggested by the BPS data. 19/ Sue Rosegrant et al p. 4.17-4.20, and C. Peter Timer et. al. The Corn economy of Indonesia. - 45 - Tale 3.9t CORN PROJECTIONS 1988 1_ 1995 2000 2010 Area Java L 1,817 1,948 2,047 2,047 ('000 ha) Off-Java I 1,179 1,264 1,396 1,396 ToQtal 2.296 3.212 3.443 3.443 Yield Java 1A 2.16 2.66 3.08 4.14 (t/ha) Off-Java 1.65 1.90 2.20 2.96 Total 6IJ 2.36 2.72 3.66 Production Java 3,930 5,182 6,305 8,475 ('000 tons) Off-Java 1,951 2,402 3,071 4,132 otga S.881 7.584 9.376 12.607 Demand (includes livestock feod) 5,740 6,797 7,654 10,095 Potential Exports lf 141 787 1,722 2,512 /a Average of 5 years centered on 1988. Source: BPS. b Area assumed to grow 1Z p.a. to 2000, as sugarcane and soybean areas are reduced on Java and zero Z p.a.thereafter. Ia Area assumed to grow at an Increasing rate as yield increases make corn more profitables 12 p.a. to 1995 and 22 p.a. until 2000. id Yield is expected to grow on Java by 3.02 p.a. La Off-Java, yield is expected to grow by 22 p.a. to 1995 and 32 p.a. thereafter. The high rate of growth of yield towards the end of the period is based on the asumption that yields off-Java will 'catch up' with those on Java. If The exportable surplus of corn would be much less if, at present, the actual corn use in feed is higher (as estimated by the industry sources) than that suggested by the BPS data. 3.37 As a result of GOt campaign In 1984 to increase soybean production, the harvested area increead to 1.2 million ha in 1989, total production reached 1.3 million tons and yields rose to 1,100 kg/ha. In 1989, yields per hectare in the main producing area of Java, Sumatra and Sulawesi, averaged 1,200 kg, 950 kg and 1,080 kg, respectively, a narrow range despite major differences in soil, climat and availability of labor and inputs. Yields of 1,500 kg/ha in traditional soybean production areas by experienced growers have been achieved. - 46 - 3.38 The main emphasis of soybean research is currently on the production of early maturing lines adapted to minimum tillage and lowland cultivation after rice. The short maturity period (less than 85 days) required to fit into the rice-dominated crop rotation during the dry season is relatively brief when compared to the 120-150 days required for some of the US and Brazilian varieties. The main problem with these fast maturing varieties is that they do not have ample time to recover if a sudden period of drought or pest attack checks the plant growth, especially during the early phases of development. In addition, the varieties are developed to switch off early from a vegetative to a reproductive phase. High pest population pressure under Indonesian tropical conditions stresses the plant, thus leading to low yields. To compensate for low yields, Indonesian soybean varieties will need to be planted at a higher plant density than is presently practiced. Breeding selections will also be required for adaptation to other major cropping systems, and criteria will have to include seed viability, tolerance to low pH/high aluminum saturation (the latter is common in acid soils), shade tolerance (for intercropping), inuect and disease resistance, and combined adaptation to both wet and dry conditions. The predominant variety, Welis, is planted in all agroclimatic areas. The lack of regional research is limiting the spread of high yielding varieties. 3.39 In spite of high domestic producer prices and other policies (paras. xx ) to promote self-sufficiency in soybean production, Indonesia remains a net importer of soybeans. Unlike in rice, full import replacement in soybeans may not be achieved at a producer price comparable to import parity. 3.40 There are three reasons for this judgement. First, numerous studies indicate that: at gresent yield levels, Indonesia is not a competitive producer of soybeans, even for import replacement. Second, and more importantly, there are agronomic constraints on soybean yield expansion. Third, even at prices above import parity and government programs to stimulate soybean production, the expansion of production has slowed. On Java, there has been little expansion of area since the early 1970s, and steady but modest yield increases. Off-Java, the area of soybeans increased rApidly in the early 1980s, but now appears to have peaked. In 1990, soybean area on Sumatra, Sulawesi and all other Off-Java regions was about two-thirds of peak levels in the 1980s. Off-Java yields have increased only slowly. 3.41 New high-yielding varieties which are suitable for Indonesian growing conditions, short growing season and crop rotations, are unlikely in the near future. As a result, the projected growth in yields is only 1.5 percent per annum. This is slower than the 2.0 percent rate of growth during the past 20 years. It is not expected that the soybean area will increase on Java. Soybean area on the outer islands is projected to increase, reversing the downward slide of recent years. Under these assumptions, production is projected to grow from 1,317 20/ thousand tons in 1989 to 2,266 thousand tons in the year 2010. 20/ Average of three years centered on 1989. 47 - Table 3.10: SOYBEAN PROJECTIONS 1989 /a 1995 2000 2010 Area Java 685 685 685 685 ('000 ha) Off-Java /b 521 622 687 837 Total 1.206 1.307 1.372 1.522 Yield Java /a 1.13 1.24 1.34 1.56 (tWha) Off-Java Le 1.04 1.14 1.g3 1.43 Total 1.09 1.19 1.28 1.49 Production Java 777 849 918 1,069 ('000 t) Off-Java 540 709 845 1,197 Total 1.317 (2.8)/d 1.558 (2.5) 1.763 (2.5) 2.266 Demand ('000 t) 1,737 2,345 2,959 4,905 Imports 420 787 1,196 2,639 ('000 t) Percent of demand met 76 66 60 46 from Domestic Production La Area, yield and production data for 1989 are averages for three years, centered on 1989, These estimates may be lower than GOI estimates, but are closer to estimates by trade sources. /b Off-Java area is assumed to increase by 3 percent per annum until 1995 and 2 percent per annum thereafter. /c Yield is assumed to increase by 1.5 percent per annum. /d Figures in parentheses are percentage growth rates over the period. 3.42 The average production growth rate over the period 1989 to 2010 is projected to be 2.6 percent per annum. This is significantly lower than the projected growth of demand for human consumption and livestock feed. Demand is projected to grow from 1,737 thousand tons in 1989, to 4,905 thousand tons in 2010. Consequently, imports are projected to rise from 420 to 2,639 thousand tons, with a corresponding decline in the proportion of domestic demand met from domestic production--from 76 percent in 1989 to 46 percent in 2010. 3.43 In view of soil-fertility improving qualities of the soybean crop, it is important to develop technology for enhancing soybean yields. Until then, accelerating the growth rate of soybean production could involve high costs in terms of other crops displaced and in terms of maintaining even - 48 - higher prices for soybeans at the expense both of consumers and of the more dynamic livestock subsector (paras. 5.40-5.46) Sugar Cane 3.44 Sugar cane in Java is primarily grown in irrigated sawah land which is most suitable for rice. To attain self-sufficiency in both crops is a difficult task, not only from the agronomic point of view, but also from economic and financial viewpoints. In Indonesia, sugar cane occupies the land for 12-14 months with the farmer receiving income from one crop. Over the same period, the farmer could grow two crops of HYV of rice followed by a secondary crop on the same irrigated sawah land and earn more income. To improve farmers' incentive to grow sugar cane in Java's irrigated land, GOI adopted a sugar/rice price ratio combined with price and input incentives and trade regulations to promote sugar cane production (paras. 5.47-5.55). 3.45 With the increased adoption of market-driven approaches to agricultural policy, GOI is increasingly finding it difficult to continue supporting sugar cane production in Java's irrigated land. Since rice is the more profitable crop, GOI has decided to gradually release the irrigated land to rice production, and extend sugar cane production to rainfed areas. Thus far, about 35,000 ha of the total sugar cane irrigated area in Java have been released to rice production with an additional 20,000 ha planned for release iiu 1991/92. To partially compensate for the loss in sugar cane production, GI is promoting sugar cane production in non-irrigated (ladang) rainfed areas in Java and outer islands. However, lower yields and increased cost of transporting cane to existing mills (not yet re-established to the new areas) have led to increased costs of production. Similarly, the economics of growing sugar cane in rainfed areas are not presently favorable due to poor soils relative to Java (which result In low cane and sugar yields) and lack rf investments particularly in new mills. 3.::,6 The agronomic problems fe-ing sugar cane production are the main stumbling block to increasing cane and sugar yields, particularly in rainfed areas. While the green revolution through adoption of HYV and increased availability and use of inputs led to rice self-sufficiency and high yields; sugar cane research was stagnant and declined not only in Indonesia, but also world wide. Market distortions and supply gluts of sugar have contributed to the decline in generation and adoption of improved sugar technology, both in production and processing. In Indonesia, the lack of an economically viable technical package could be attributed to the following: (a) stagnation in varietal development resulting in planting one variety (Mauritius 445), which has a high fiber and low sucrose content in about 80 percent of the cane area; (b) decline in crop management practices particularly matching of soil fertility requirements and needed fertilizer inputs; (c) increased cost of agrochemicals and soil amendments (lime) particularly for the outer islands; (d) increased pest problems; and (e) decline in contractual benefits to sugar cane growero as payments are based on sucrose content of delivered cane. The steady decline in the sugar content of cane from 11-12 percent durirng the 1970. to 7-8 percent at present ts probably the most important factcr contributing to decline of sugar production. If reversed, the goal of increased domestic production to meet most of the domestic demand could be theoretically met. However, rehabilitation of old mills and adoption of new - 49 - efficient sucrose extraction methods is a limiting factor to increased sugar production. 3.47 In Indonesia, about 150,000 ha of sugarcane are currently grown on sawah land. Even at support prices which are about twice import parity, returns to sugar cane production on sawah land are less than those from competing crops of paddy and palawija. Farmers are required to grow sugar cane although it reduces their incomes below what they otherwise would be. Further, various studies have shown that at import parity prices, sugar cane production is no longer an economically efficient use of land in Indonesia, both on Java and also Off-Java.21/ 3.48 Government policy is to phase out sugar cane production on sawah land on Java and to expand sugar cane production off-Java, both to replace production displaced from sawah land on Java and to meet increasing sugar consumption demand. The time-phasing of this process has not been announced. Further, a better policy might be to expand imports. For many other crops, such as the foodgrains, such a policy choice need not arise: the choice of local production expansion or expanded exports can (and in most cases, should) be left to market forces and the decisions of farmers and importers. For sugar, on the other hand, the decision to construct a mill must precede the farmer's decision to produce sugarcane. Further, locating new sugar mills off-Java in most instances requires prior provision by public authorities of supporting infrastructure. For these reasons, a policy choice has to be taken. 3.49 Based on present evidence, it is difficult to recommend expansion of sugar cane production off-Java. First, studies such as that previously cited show that Indonesia is not an efficient producer even off-Java. Second, the experience of completed sugar projects off-Java support these economic analyses. For example, the sugar production costs of the recently-completed NES Sugar Project (Loan 2344-IND) are almost double the import parity prices and the project is not even financially viable at supported prices.22/ 3.50 To offset this gloomy prognosis, it is clear that the present world sugar price is depressed by the protectionist policies of the EEC and other countries. Successful negotiations under the auspices of GATT, could lead to liberalized agricultural policies and substantial increases in world sugar prices. This would lead to a structural transformation of the world sugar economy and could change the optimal policy choice for Indonesia. But the uncertainties conuerning whether and, if so, when such changes in policy might 21/ See e.g., Mark W. Rosegrant et al, Price and Investment Policies in the Inlonesian FoodcroDs Sector, IPPRI and CAER, 1987, pp. 2.21-2.25 and pp. 4.26 to 4.27. 22/ This project was designed as a pilot project to test the viability of sugar cane production under rainfed conditions on the Outer Islands. The outcome of the pilot project can only be interpreted as negative. MOA provided data for other PTPo, which indicated higher yields than for the NES Sugar Project. But no firm conclusions could be drawn because the data were not comparable. - 50 - occur are great. Under these circumstances, a prudent policy would be to: (a) continue with the phase-out of sugar on sawah land on Java (and certainly not to replace the antiquated sugar mills serving these lands), (b) allow increasing domestic demand to be met mainly by expanded imports and (c) maintain a modest program of research to identify/develop cane varieties suitable for rainfed conditions on the Outer Islands (para. 4.42). 3.51 These uncertainties make it exceptionally difficult to project future output growth. In its Agriculture Sector Model, BAPPENAS has projected the growth of sugar cane output at 2.87 percent a year from 1989 to 1992 and at 4.08 percent a year from 1991 to 2000. Extrapolating back to 1988, this iG equivalent to growth over the period 1988 to 2000 of 4.02 percent per annum. AARD has projected sugar cane production to grow at 3.3 percent a year from 1988 to 2000. These growth rates seem high both by past standards and on account of the policy to stop sugar cane production on Java sawah land. As a result, this report has assumed a more conservative growth rate of 2.0 percent per annum for sugar cane production over the whole period 1988 to 2010. Should the consumption of sugar increase rapidly as diets improve, fairly sizeable imports could be required. Root Crops 3.52 Cassava and sweet potatoes are inferior goods and consumption per capita is projected to decline at a faster rate than population increase. This leads to negative growth for total demand. Since export markets for root crops are extremely limited, supply is projected to change at the same rate as domestic consumption for these products. fruit and Veaetables 3.53 The demand for fruit and vegetables is growing at a high rate in Indonesia because of high income elasticities of demand. This rapid growth is expected to continue. Consumption of fruit is projected to grow at more than 5.5 percent per annum from 1988 to 1995, accelerating to about 6.4 percent per annum during the next fifteen years. Consumption of vegetables is projected to grow at slower rates-by 3.6 percent per annum between 1988 and 1995 and 3.9 percent per annum between 1995 and 2010. 3.54 Rural households are largely self-sufficient in fruit and vegetables, each family meeting its own needs by production (or exchange with neighbors) in its own house compound. The commercial demand for fruits and vegetables is largely from urban areas. At present, there is little international trade in these products, although such trade is now growing as a result of reforms undertaken in the June 1991 deregulation package. 3.55 It was estimated that by 2010, almost 200,000 ha of land would be required to meet the incremental urban demand on Java for fruits and vegetables (para. 3.6), or a little more than 2 percent of the arable land base in 1985. The requirements of sawah land were only about 4 percent of that available in 1988. The availability of suitable land, therefore, will not constrain the growth of fruit and vegetable crops. Under these circumstances, the supply of these products is projected to grow at least at the same rate as domestic demand. The need for an assessment of the export - 51 - market requirements and potential is discussed in Appendix D, Volume II. Increased emphasis will also be needed on technology generation in the context of farming systems. Livestock Products 3.56 Like horticultural products the growth of most livestock products is assumed to be driven mainly by the growth of domestic demand. Given the adequate supply of feedstuff, particularly corn, and given that soybean and other protein meals can be made available to livestock producers at close to import parity prices, production of poultry and other meats should keep pace with demand. For eggs, poultry, pork and goat meat, the rate of growth of supply is assumed to be equal to that of demand. An assessment of the constraints, including livestock diseases, inadequate forage resources, and lack of good animal husbandry, as well as an evaluation of the export potential of livestock products, is needed (para. 7.23). Fishery Products 3.57 The fishery subsector is one of the larger subsectors of agriculture, contributing almost 8 percent of agricultural CDP in 1988. It is also a diversified subsector, producing a wide range of products using diverse production techniques. Production and processing activities are also widespread geographically. Fish production has been increasing by about 6 percent per annum in recent years, making it the most dynamic of the subsectors. This rate of growth is expected to decline somewhat in the future because of stock depletion in some established marine fisheries, but a growth rate of about 5 percent still seems feasible for several decades. Along with the rapid growth of production, continued expansion of exports is anticipated. 3.58 According to the FAO statistics, Indonesia produced 67,470 t of shrimp in 1989. This placed the country as the third largest producer in the world, after China and Ecuador, and with a share of 12.6 percent of the total world production. The shrimp agqaculture industry is presently believed to be the second largest in the world. With large mangrove land considered suitable for brackish water aquaculture, and only a third used at present, Indonesia offers enormous potential for development of the industry. Marine fisheries account for over 60 percent of total production. Catches from three areas, North Coast of Java, Malacca Strait, and South Coast of Sulewesi are now exceeding 65 percent of maximum sustainable yields (MSY). The Asian Development Bank 23/ estimates an economic harvest potential (at current prices) of 3.5 million tons, or 52 percent of MSY. In addition, the D.G. Fisheries' (DGF) estimate of MSY (6.7 million t.) is high compared with an FAO/UNDP estimate of 4.5 million t.241 It is evident that these areas are close to the limit of economic exploitation of the resource. Some coastal fisheries of Java, which are exploited mainly by small (mainly impoverished) 23/ ADB, "Appraisal of the Second Fisheries Industries Credit Project in Indonesia," Report LAPt IND 23073 (Restricted), July 1991, page 3. 24/ Ibid, p.3. Good conservation practice would argue for accepting the lower figure until better estimates are available. - 52 - Table 3.11: FISH PRODUCTION AND SUSTAINABLE YIELDS ('000 tons): 1988 Maximum Sustainable Yields (MSY) Exclusive (Marine Production Territorial Economic production)/MSY Location Marine Waters Zone Total (percent) North Coast of Java 413 278 - 335 148.6 Malacca Strait 351 267 68 335 104.8 South Coast of Sulawesi 287 425 - 425 67.5 Bali East Nusa Tenggara 217 333 173 506 42.9 East Coast of Kalimantan 100 265 - 265 37.7 North Coast of Sulawesi 113 301 167 468 37.5 East Coast of Sumatra 161 277 545 822 29.5 West Coast of Sumatra 146 212 400 612 23.8 South-West Coast of Kalimantan 103 508 - 508 20.3 South Coast of Java 88 167 491 658 13.4 Maluku Irian Jaya waters 190 1,358 480 1,838 10.3 Total 2.169 4.391 2.324 6.715 32.5 Source: DG Fisheries data (provided on March 16, 1992). fishermen, have been pushed beyond MSY, with declining catch3s aS a consequence. 3.59 By contrast, only about 10-20 percent of MSY has been exploited in Maluku-Irian Jaya, South Coast of Java, and South West Coast of Kalimantan. Therefore, there is probably a considerable scope for expanding marine fisheries in these areas. Potential for marine capture fisheries and the potential for exploitation of tuna resources is large, particularly in Eastern Indonesia. The present areas of shrimp culture on the northern coastline in Java, however, are vulnerable to water pollution from industrial and urban expansion. 3.63 Production, demand, and export projections are presented in Table 3.12. At an estimated rate of growth of 5 percent per annum over the period, aggregate proCuction is expected to grow faster than domestic demand (4.8 percent per annum). leading to increasing quantities available for - 53 - Table 3.12: FISH PRODUCTION AND DEMAND PROJECTIONS ('000 t.) 1988 la 1995 2000 2010 Production /b 2,880 4,105 5,239 8,534 Domestic ccnsumption /a 2,737 3,885 4,936 7,712 Net exports ld 143 (6.3) 220 (6.6) 303 (10.5) 822 L& Data for 1988 are not averages, but actual 1988 data. Includes aquaculture and fresh water fisheries. Lb Growth rate of 5 percent per annum is assumed, ADB, op cit, page 49, projects 5 percent growth per annum from 1988-93. This growth is expected to continue, based upon expansion of inland fisheries and unexploited marine resources in east Indonesia and off Kalimantan. Ic Domestic consumption in the base period is "total domestic supply", including meal for livestock feeds. (ADD p. 49). The growth rate of domestic demand is that estimated in Chapter II of this Report. Id Figures in parentheses are growth rates for the periods. exports. The potential growth in exports is 8 percent per annum over the projection period. 3.61 The main issues in the fisheries subsector includet * a more accurate stock assessment to establish MSY for the different commercial species, given the wide divergence between the DGE and the ADB estimates; * monitoring and regulation of water quality standards, particularly on Java (paras. 3.22 and 3.23); e recognition that the future of impoverished marine fishing communities on Java and Sumatra probably does not lie in fisheries in their existing locations. Therefore, adjustment assistance in operating new fisheries off the central islands or in moving to sectors outside agriculture Is required; * the use of unexploited marine fishery resources in eastern Indonesia as a vehicle for development of those areas, including processing and transportation facilities. This involves the avoidance of enclave developments, aimed solely at export promotion, which have limited backward linkages to the local economies. * with regard to shrimp aquaculture industry, constraints may come from: (a) product quality inconsistencies; (b) poor post-harvest handling; (c) low world shrimp prices, following the world price drops of 1989; (d) possibility of occurrence of diseases, mainly by - 54 - deteriorating water quality; and (e) shortages of low-cost, high-quality aquaculture feed. Other Commodities 3.62 Projected growth rates for major tree croa Products are indicated in Table 3.13. These are based primarily on the sector review 25/ undertaken by the Bank in 1989. Growth rates for production of beverages, 3.0 percent per annum during 1988-2000 and 2.8 percent per annum from 2000-2005, are assumed to be the same as those estimated by BAPPENAS and by AARD. With regard to soices, this report used an average of the projected growth rates for six spices, as estimated by AARD.26/ A growth of 1 percent per annum for forestry products is assumed. This estimate is obtained from GOI1's draft Tropical Forestry Action Plan. Table 3.133 GROWTH RATES OF MAJOR TREE CROP PRODUCTS (S per annum) 1988-1995 1995-2000 2000-2010 Palm Oil la 8.3 2.2 2.0 Coconut Oil 3.3 3.2 3.2 Rubber 3.5 2.1 -1.6lb /a Includes palm kernel oil. this is a conservative estimate and it could be higher in view of a major expansion in the private sector nucleus estate (PIR-TRANS) program. lb The potential output decline after the year 2000 can be reversed by a faster rate of planting than a mere replacement of the outgoing tree crop stock. This may require an increase in area to be planted and/or a major replanting program to replace unselected planting material with improved varieties which can increase yields. Summary Qf SuPDYly Proiections - Comparative Analyses (various studies) 3.63 Agricultural supply projections have been recently completed by BAPPENAS using an Agricultural Sector Model (the BASM projections) and by AARD. Projected growth rates from these studies for 1991-2000 (BASH) and for 1988 to 2000 (AARD) are presented in Table 3.14. 3.64 For many crops, broadly similar conclusions are reached. The BASH model projects a much lower growth rate for rice (1.3 percent) than the other 251/ World Bank, Indonesia: Strategies for Sustained Development of Tree Crops. Report No.7697-IND, December 7, 1989. 261 Ibid. - 55 - Table 3.14: PROJECTIONS OF SUPPLY OF AGRICULTURAL PRODUCTS (percent per year) Product BASM /a AARD /eL Mission Group 1991-2000 1988-2000 1988-2000 2000-2010 Rice 1.3 3.2 3.2 1.9 Corn 3.9 3.0 3.8 4.3 Root crops 3.5Lb 1.4L/ -0.1 -0.9 Sugar 4.1 3.3 2.0 2.0 Soybean 5.6 3.4 2.3 2.5 Vegetable. n.a. 0.9 3.7 4.0 Fruit n.a. 1.0 5.7 6.6 Meat 4.4/c 4.11c 5.4/c 6.5Lc Eggs n.a. 4.8/L 6.2 5.3 Fish 4.4 n.a. 5.2 4.6 Coconut 3.7 4.9 3.3 3.2 Oil palm 6.4 18.6 5.7 2.0 Rubber 4.5 5.4 2.9 -1.6 Beverages 3.3td 2.81d 3.01d 2.8/d Spices n.a. 2.81h 2.8 2.8 Forestry n.a. n.a. 1.0 1.0 n.a. Not available. La BAPPENAS Agricultural Sector Model, Rice at export parity price. in Cassava. /c Weighted average of poultry (0.35) and other meat (0.65), weights from BAPPEMAS Ag. Sector model. Production increases are assumed to equal the increases in domestic demand. id Coffee only. LI AARD. /f Cassava and Sweet Potato. La Rate of growth of modern technology layers. Lb Average of six spices. Mission projection accepts the AARD estimate. studies (3.2 and 2.0 percent). This may be due to the fact that BASH projections are based on el2ort parity prices rather than import parity prices, which are the prices prevailing at present in Indonesia. All studies project high (3.0 was the lowest) growth rates for corn. This report assumed a much lower growth rate for sugar (2.0 percent) than the other studies (4.1 and 3.3 percent), and for soybeans (2.5 percent) relative to the others (5.6 and 3.4 percent). The reasons for this report's low estimate of soybean production potential are set out in paras. 3.37-3.43. It may be the case that the high projections for soybean production, which were done by government agencies, contain an element of target-setting. - 56 - 3.65 It may be noted that diveraification is occurring and will continue as an outcome of not only differential rates of growth of demand (Chapter II), but also of technical change. This Is essentially a market-driven proceos entailing farmer response to price signals. Diversification is towards products with (a) high Income elasticitiesl and (b) high land-use intensity. These notably are horticultural, fishery and small (poultry in particular) livestock products. Grains (particularly rice and corn) will continue to dominate, although rice will not be a prime mover of the sector or of the increased value-added activities. - 57 - IV. EVOLVING PUBLIC INSTITUTIONS/SUPPORT SERVICES AMD INCREASING ROLE OF PRIVATE SECTOR Government Expenditures-Trends and Priorities 4.1 Overview. After evaluating the demand and supply prospects (previous two chapters), this section focuses on the evolving and enabling Tole that the public and private institutions will need to play to realize those prospects. Past trends of public expenditures in agriculture indicate Government's strong commitment to the sector. Tho challenges that lie ahead suggest that the pattern of Government expenditures needs to be altered with less spending on fertilizer subsidies and new irrigation developments, and more on research, extension, O&M, and infrastructure. With regard to research and extension, future priorities and organization for commodity research (particularly, the decentralized, regional approaches) are diacussed in detail. The scope for enhancing the role of the private sector in production (PTPs), marketing (BULOG), and the provision of support services and inputs (research, extension, seeds, pesticides, fertilizer and agricultural machinery) is examined. 4.2 Overall Levels. Public expenditures on agriculture 2?/ in Indonesia in the 1980. have been relatively high by developing country standards. Between 1984-88, public expenditures on agriculture in forty developing countries averaged 7.5 percent of total budgetary expendi- tures.28/ By contrast, over the same period, Indonesia devoted 9.3 percent of its total budgetary expenditures to agriculture. A more useful comparison is the expenditure ratio" 29/ which takes into account the importance of the agricultural sector in the economy. A higher ratio implies a greater relative emphasis on agriculture in public expenditures. Over the period 1984-88, Indonesia ratio was 0.4, compared with 0.3 for the sample as a whole. Table 4.1 provides comparisons with selected countries for the period 1984-88. 4.3 Table 4.2 provides a more detailed overview of agricultural expendit:ures in Indonesia for the period 1982/83 to 1990/91. The absolute 27/ Includes Central and Provincial Government expenditures on agriculture and irrigation, plus 40 percent of expenditures on transmigration. The total annual fertilizer subsidy, whether paid through the budget or through credit from BRI, is also included. Other directed credits in agriculture are not include . A complete breakdown Is given in Annex III, Table 3.6, Volume II. 28/ "Public Sector Expenditure'. Policy Role in Agricultural Growth and Adjustment," Odin Knudsen and John Nash (Draft Mimeo), May 1991. Expenditures include both routine and development budgets. 29/ Defined as the ratio of (agricultural expenditures/total expenditure) to (agricultural GDP/total GDP). - 58 - Table 4.1: PUBLIC EXPENDITURES ON AGRICULTUREt INDONESTA VS. SELECTED OTHER COUNTRIES, 1984-88 AVERAGE As Z of Total Agriculture Agriculture GDP/ expenditure GDP Total GDP "Expenditure Ratio"./L Thailand 10.5 11.9 17 0.62 Indonesia 9.3 8.23 0.41 Mexico 3.6 10.5 9 0.40 India 8.3 4.9 32 0.26 Nigeria 8.4 4.7 34 0.25 Philippines 5.7 2.9 23 0.25 Bangladesh 11.5 2.7 46 0.25 Turkey 1.5 2.1 17 0.09 La Ratio of (Agric. Expenditures/Total Expenditures) to (Agric. GDP/Total GDP). Source: World Bank Staff estimates and IMF Government Financial Statistics. Table 4.2: INDICATORS OF PUBLIC EXPENDITURES la ON AGRICULTURE, 1982/83-1990/91 (Rp billion) 1982183 19B5186 l9o6w17 1987/88 1988/89 1989/90 1990191 tv. 1990/ Total A4t. onditures Lb 3,106 3,233 2,376 2,999 3,155 2,733 2,602 2.806 Ag. CDP 9.1 9.1 7.0 8.7 8.5 6.7 6 3 Total GDP 1.7 2.0 1.6 1.9 2.0 1.5 1.3 Total Rapendituree 8.7 9.2 8.2 10.0 10.2 8.1 6.7 U:5 'Expenditive Ratio" Id 0.46 0.41 0.35 0.45 0.44 0.36 0.32 119 .& D"6lo111 -in r - 3,018 3,137 2,267 2,897 3,049 2.631 2,472 2.699 -a. o Oa101t Developuant emp nditurec 16.3 17.8 21.3 19.5 18.6 15.3 14.4 17.2 a Itclude. routin and davelopent eapendtiturec. Constant 1990/91 tcrm. C All ratios ore to current term. Ratio of (Agric. zpe ndituree/totsl Zpeditursr1 to Agric. ODP/Totcl ODPJ. Soures Ministry of Pnane* ad World Dank Staff Zt tatos. level of expenditures or. agriculture has varied substantially over the last decade but has averaged about Rp 2.8 trillion,30/ or about 8 percent of 30/ All figures are in 1990/91 terms unless otherwise noted. - 59 - agriculture GDP. The development budget 31/ has accounted for almost 97 percent of total agriculture spending. Although the "expenditure ratio" for agriculture has fallen since the early 1980s, agriculture vas relitively more protected than other sectors from the budget cuts that followed the sharp drop in oil revenues in 1986. In 1986/87, total development expenditures on all sectors fell by about 37 percent in real terms, but development expenditures on agriculture fell by only 24 percent, raising agriculture's share of total development expenditures to 21 percent from only 13 percent three years earlier. This helped Indonesia maintain the momentum of agricultural growth during the second half of the decade, and it helped contain the effect on the rural poor of the Government's stringent fiscal measures.32/ Agriculture's share of total development expenditures fell slowly to 14 percent by 1990/91, but expenditures in real terms for that year were roughly equal to the average for the decade. Excluding the fertilizer subsidy, expenditures on agriculture were more than 10 percent higher in 1990/91 than the average for the decade, although they were 15 percent below their 1988/89 peak. 4.4 Funding for agricultural development expenditures has increasingly come from foreign assistance (Table 4.3). Between 1982/83 and 1985/86, the proportion of foreign financing for agricultural expenditures avaraged 12 percent. Following the oil revenue decline in 1986, however, the importance of foreign financing grew rapidly, reaching 40 percent in 1990/91. This rate of increase in reliance on foreign funding has greatly exceeded the rate of increase for the budget as a whole. Excluding the feetilizer subsidy, over 55 percent of agriculture expenditures are finar.ced from foreign sources, up from 16 percent in 1982/83. Within agriculture, several subsectors are highly dependent on foreign aid. These are estate crops (77 percent), research (76 percent), and new irrigation developmAent (68 percent). While these data need to be interpreted with caution, they do raise a question about the Government's (as opposed to donors') commitment to the subsectors. 4.5 Expenditures at the Provincial Level. Provincial Governments have little control over budgetary expenditures on agriculture. Staff of the Departments of Agriculture and Public works stationed in the provinces report to the Governor but are paid by the Central Government. Provincial authorities, in addition to being responsible for operation and maintenance of the irrigation infrastructure, also administer small projects in most subsectors. On average, however, spending on projects administered at the 31/ "Development" expenditures are largely, but not entirely, investment in nature. However, development expenditures also include fertilizez subsidies and irrigation O0&, which generally are considered recurrent in nature. In addition, preliminary analysis suggest that 15-20 percent of other development expenditures are also recurrent. In all, some 40 percent of agriculture development expenditures are estimated to have been recurrent in nature for 1990/91. 32/ For further analysis, see A World Bank Country Study Indonesia. Strategy for a Sustained Reduction in Poverty9 World Bunk, Washington, DC, 1991. - 60 - Table 4.3: TRENDS IN FOREIGN FINANCING La (Z of total expenditures) 1982/83 1986/87 1990/91 Total Agriculture 11 21 40 -- (excllxig fertilizer) (16) (43) (56) Food crops 2 14 43 Livestock 18 50 49 Fisher'.s 18 47 49 Estate crop. 52 60 77 Research 38 73 76 Irrigation 8 42 59 -- (New development) (13) (57) (68) Total All Sectors 35 39 49 La Development Budget only. Source: Ministry of Finance and Bank Staff estimates. provincial level has been only 7 percent of total development expendi- tures 331 on agriculture with nearly two-thirds of provincial agricultural development expenditures for irrigation O&M alone. The current structure of provincial gOvernment finance leaves littla flexibility for increasing or reallocating agricultural expenditures according to local needs. Four-fifths of provincial revenues come from the Central Government via INPRES and related mechanisms that have strict guidelines on what the money can be spent for. 4.6 Proarammina and ComDosition of Exvenditiures. Programming of agricultural expenditures is a complex process involving several Ministries. The Department of Finance coordinates an inter-departmental committee that sets fertilizer prices, thereby determining the subsidy level. The Department of Public Works is in charge of budgeting and implementation of irrigation investment. The Department of Agriculture controls budgeting and implementation of research, extension, and other support for various agricultural activities. The Department of Transmigration has a separate budget for agriculture-related activities, although some of these activities are Implemented by the Department of Agriculture. The Department of Home Affairs channels the INPRES Funds to the Provincial Governments. Within BAPPENAS, oversight of the non-fertilizer, non-transmigration budget is under one Bureau Chief, who faces the daunting task of ensuring coordination between the Departments of Agriculture, Public Works and Rome Affairs. The 33/ Excluding the fertilizer subsidy; if the fertilizer subsidy is included, the proportion falls to 3 percent. - 61 - transmigration program i. handled by a different Bureau Chief who reports to a different Deputy at the BAPPENAS. 4.7 Chart 4.1 shows the ompodltion of agricultural expenditures over the past decade. The picture to strlking: expenditutes on fertilizer/ pesticide subsidies and Irrigation have made up over two-thirds of the total (in 1984/85 they reached 72 percent). Over the decade, about 8 percent of agriculture-related expenditures have been on the transmigration program. Thus, the Department of Agriculture controlled only about a quarter of total expenditures on agriculture. Of this share, estate crops accounted from 11 percent, food crops 5 percent, and livestock, fisheries, research, and training about 2-3 percent each. 4.8 Expenditures on fertilize/psticide subsidies are determined via the Government's price policy rather ti2an through the budget process. As part of the drive toward rice self-sufficiency in the 1970s and early 1980s, the Government maintained the domestic retail price of fertilizer and pesticides well below world prices3j41/ From 1977 to 1984, the real price of fertilizer in Indonesia fell by over 50 percent, and subsequent price increases have raised the price of fertilizers to only 55 percent of the level prevailing in 1977. Low fertillser prices Induced farmers to move rapidly up the "learning curve" with respect to the benefits of fertilizer application and new high-yielding rice varietie. Between 1974 and 1986, total fertilizer use in Indonesia more than quadrupled, and rice output rose by over 75 percent. 4.9 The subsidies on fertilizer and pesticides were unaffected by the budget cuts following the collapse of oil prices in the mid-1980s, and have risen rapidly, more than doubling In 1984/85 alone. They reached more than 50 percent of total agriculture expenditures.1I/ The pesticide subsidy was abolished in 1988/89, due to environmental concerns and the role of excessive and broad spectrum pesticide application In provoking major pest atticks. This reduced the total subsidy burden by about one-fifth, and by 199u191 the subsidy had fallen back to about 30 percent of total expenditures on agriculture. 4.10 By the late 1980s, fertilizer application rates were extremely high compared to other 'Asian countries. field studies over the past few years have shown that marginAl physical returns to urea applications at current levels are extremely low. For rice, It Is estimated that TSP, KC1, and AS usage could be reduced 25 percent or more with virtually no decrease Jn yields. Most studies show that marginal returns to urea are close to zero. Consequently, there is little doubt that economic returns to the fertilizer 34/ On average, urea and TSP, which represent four-fifths of total fertilizer usage, have been subsidized at the farmgate by about 50 percent since the mid-1970s. (See GATT, Trade Policy Review Mechanism: The Republic of Indonesia (Report by the Secretariat), March 18, 1991, pp. 28). 351 Since the mid-1980s, part of the fertilizer subsidy has been financed through borrowing from State Co =s rcial Banks and therefore is off- budget. Chart 4.1: Agriculture Development Expenditures By Program Rp. Billion (constant 1990/91 terms) 350t) - 3000 - .....-..........-... . ................ 2500 -' ... _ _ ...... ... _ : .:':: 1500 -1 -W -- - - -I1 -L 1000 - ..... o~~~~~~~~~~~~~~~~~~~~~~ 1 5 0 0 .. . . - . . . ..-..... - . . . . . . . . - . 0 1982/83 1984/85 1986/87 1988/89 1990/91 EFertilizer * j Irrigation EWTransmigration MEstate Crops EZFood Crops LjLivestock ** 3Research/Training *Inc aLdes Pesticide Subsidy *Includes Fisheries - 63 _ subsidy now are low, if not negative. Since TSP, KC1 and AS fertilizers together account for three-quarters of the financial subsidy (Table 4.4), priority should be given to raising their prices toward economic levels. Urea prices also need to be raised substantially. Continuing concerns within the Government about the pocsible negative effect on rice yields of higher urea prices should be addressed through intensified field trials and on-farm monitoring. Table 4.4: BREAKDOWN OF FERTILIZER SUBSIDY, 1991/92 Urea TSPIa AS/b KCllc Total/Avg. Financial subsidy 1d 169 352 62 46 629 -- (2 of total financial subsidy) (27) (56) (10) (7) (100) Economic unit subsidy (2) /e 50 37 21 24 42 1. Triple Superphosphate !b Ammonium sulphate Le Potassium chloride .Ld Rp billion, current terms, calculated as the financial cost of procurement and delivery minus the retail price. /a Percentage by which actual retail price is lower than world price equivalent. Source: Ministry of Finance and Bank Staff estimates. 4.11 Expenditures on fertilizer/pesticide subsidies were greater than those on irrigation-often by a large margin-until 1988/89. In that year, the share of irrigation rose to 36 percent, compared with 30 percent for fertilizer/pesticides (Table 4.5). In the past three years expenditures on irrigation have averaged over 35 percent of total expenditures, while those on the fertilizer subsidy have dropped below 30 percent (Chart 4.1). Within irrigation, the bulk of expenditures have increasingly been on new development, as opposed to rehabilitation, operations and maintenance. Expenditures on new development rose by over 70 percent in real terms in 1988/89 and have remained much higher than earlier in the decade. Increased expenditures are due largely to rapidly rising unit costs (see Table 3.4) for new area expansion. Most of the land suitable for new command area has already been developed, with the result that recent development has taken place in less accessible and more remote areas. As a result, unit costs have doubled in real terms over the past decade. Not surprisingly, economic rates of return for new developments are generally well below 10 percent. Low rates of return are also caused by the failure to carry out adequate engineering and economic feasibility studies before investments are undertaken. In addition, there is poor coordination between DGWRD and the Ministry of Agriculture regarding land development. - 64 - Table 4.5s FERTILIZER SUBSIDY AND IRRIGATION EXPENDITURES (Rp billion 1990/91 terms) 1983/84 1984/85 1985/86 1986/87 1987/88 1988/89 1989/90 1990/91 Fertiliser/pesticide subsidy /a 610 1,288 1,381 1,184 1,068 907 755 7001.d (S total) lb (30) (46) (44) (52) (37) (30) (29) (28) Irrigation /c 586 741 775 431 667 1,097 1,073 880 (2 totalj lb (28) (26) (24) (18) (23) (36) (40) (35) of which O&M 33 44 46 43 45 54 70 107 a Includes pesticide subsidy until its abolition in 1988/89. Total Agricultural Development Expenditures. Includes new development, rehabilitation, O&M, and swamps. dOI's revised estimate Indicated Rp 675 billion. Sources Ministry of Finance and World Bank Staff estimates. 4.12 Operation and maintenance (O&M) of the irrigation system has been neglected until very recently, with the result that the irrigation infrastructure has required rehabilitation at least twice as often as it should have. On average, systems in Indonesia require rehabilitation every ten years, whereas, systems should last at least 30 years-actually indefinitely-without rehabilitation if they are properly maintained and include replacement provisions. Efficient operation and maintenance requires expenditures of about Rp 33,000/ha. By contrast, funding for O&M has been less than half that amount over the past decade. 4.13 Box 4.1 demonstrates the effects of inadequate O&M on the long-run costs of maintaining the irrigation system. It indicates that the Government is spending three times as much via frequent, high-cost rehabilitation than what is necessary to maintain its irrigation infrastructure. 4.14 In 1987, the Government instituted a program of efficient operation and maintenance. In 1990/91, the program covered about 20 percent of the publicly irrigated area. This has raised overall per-hectare expenditures on irrigation by about two-thirds in real terms. In order to finance such a program for all of the publicly irrigated area, however, expenditures would have to increase by a further 75-80 percent or about Rp 80 billion in 1991 terms. 4.15 In addition to the support provided through the fertilizer subsidy and irrigation development, the food crop subsector has on average received about a 5 percent share of agriculture expenditures. Most of these expenditures have been for extension activities and for intensification programs involving free or subsidized seeds and other inputs. Rice and soybeans have benefitted the most from these programs. Increased expenditures in the last few years have raised the food crop subsector's share of expenditures to 7 percent. - 65 - Box 4.1: BENEFITS OF OPTIMAL O&M Scenario As Spending on O&M - Rp 33,000/ha/year (optimal level) Rp 3 million in rehabilitation in year 30 NPV - Rp 454,000/ha. Scenario Bs Spending on O&M - Rp 16,500/ha/year (current actual) Rp 2.0 million spent on rehabilitation every 10 years NPV - Rp 1,339,000/ha. Sources Bank staff estimates. Notet Figures are in 1991/92 terms. Discount rate used is 10 percent, but the result is relatively insensitive to the rate chosen. 4.16 The estate crons subsector has received about 11 percent of agricultural development funds over the past decade. If quasi-fiscal operations 36/ in the subsector are included, the total would probably be closer to 15 percent. Design, management, and cost recovery problems slowed implementation of the established NES and PHU-style programs in the late 1980s, but the Ministry of Agriculture then devised a private sector nucleus estate-based scheme, which helped maintain the momentum of plantings in the sector (primarily for oil palm). This scheme, called PIR-Trans, is financed almost entirely quasi-fiscal through subsidized liquidity credits from Bank Indonesia. Following the Government's decision in January 1991 to reduce dramatically the scope of liquidity credits, no further approvals have been given for PIR-Trans projects, although ongoing projects will receive financing until completed.37/ The Government and foreign donors are now experimenting with new schemes to revitalize the PMU approach for planting rubber, coconut, and other crops. 4.17 The livestock and fisheries subsectors have each received about 2 percent of agricultural expenditures. In addition to funding for extension, there have been several credit-based programs in both sectors which aimed at increasing smallholder production. As with the estate crop sector, however, 36/ Due to frequent changes in the composition of on-budget vs. quasi-fiscal financing (non-Government expenditures financed through subsidized/ directed bank credits), the trends in expenditures shown in the tables should be interpreted with caution. 37/ As of March 1991, about 65,000 ha of nucleus estate land and 86,000 ha of sauallholder land had been planted. Another 75,000 ha of estate development and 215,000 ha of smallholder land have been approved for development over the next two years at a total cost of at least Rp 600 million. - 66 - these programs have suffered from major cost-recovery problems-especially in livestock, where credit was supposed to be repaid in kind. Real expenditures on both subsectors have fallen since their peaks in 1987/88-by nearly one-half in the case of livestock. Tat,l 4.6s DEVELOPMENT EXPENDITURES ON RESEARCH (Rp billion, 1990/91 terms) 1982/83 1986/87 1987/88 1989/90 1990/91 Research Expenditures 104 112 88 71 78 --as Z of Ag. GDP /a (0.31) (0.33) (0.26) (0.17) (0.19) --as S of Ag. Devt. Exp. (3.4) (4.9) (3.0) (2.7) (3.1) /a Calcilated in current terms. Source: Ministry of Agriculture, Ministry of Finance, and Bank Staff estimates. 4.18 The proportion of expenditures devoted to research has averaged about 3.5 percent. However, real expenditure on research have fallen by one- quarter since 1986/87 when the proportion was nearly 5 percent (Table 4.6). Expenditures on agricultural research are equivalent to only about 0.2 percent of agricultural GDP in Indonesia. This is below the average for South Asia (0.5 percent), Africa (1.0 percent), and North America and Oceania (2.0 percent).38/ Because of the low level of financing for research in Indonesia, funds used for actual research (as opposed to salaries, infrastructure, etc.) have been grossly inadequate. The number of qualified research personnel has increased from 220 to over 1,400 in the past ten year., but the declintng operational budget has meant that many of these researchers do little work. In the 1991/92 budget, for example, only about 23 percent of expenditures will be used for actual operational research.39/ Inadequate funds for travel and time spent in the field (along with poor career incentives for staff) have also contributed to poor linkages between research and extension. Expenditures on travel fell by about two-thirds in real terms frrc'u 1982/83 to 1988/89. Maintenance funds have also been inadequate to prevent serious deterioration of the considerable infrastructure constructed a/ World Bank Staff Appraisal Report, Agriculture Research Management Project Ln. 3031, Report No. 7504-IND (March 1, 1989). p. 13. Th4s project recommends a level for Indonesia of 2 percent of GDP. 39/ See Republic of Indonesia Agency for Agricultural Research, and Development/Asian Development Bank, "Marginal Farmer Community Development Project, "TA No. 1400-IND, Phase One Report (Huntings Technical Services and PT Tricon Jaya), September 1991, p. 13. - 67 - over the past decade. Real expenditures on maintenance fell by over one-half from 1982/83 to 1988/89.40/ 4.19 There is particularly severe underfinancing of non-rice crops. For example, even though the number of researchers working on corn has increased substantially over the past decade, the total 1990/91 research budget was only about Rp 110 million, or half a percent of the total research budget, even though corn accounts for about 6 percent of aaricultural GDP. Funding for research in the emerging livestock subsector is also low, especially on improvements needed in animal husbandry, forage provision and on control of animal diseases.38/ Both corn and livestock have substantial promise in Indonesia. 4.20 Expenditures on extension were hard hit by the budget cuts of the mid-1980s. It is difficult to estimate total expenditures on extension, since extension duties are spread throughout each directorate in the Ministry of Agriculture. Nevertheless, data on allowances 41/ given to subject matter specialists (PPS) and field extension workers (PPL) are revealing (Table 4.7). Total allowances (in real terms) per PPS have fallen every year since 1985/86, Table 4.7: EXPENDITURES PER EXTENSION WORKER (i%p '000, constant 1990/91 terms) (Budget) Total Decline 1985/86 1988/89 1990/91 1991/92 (1985/86-1991/92) PPS /a Total 1,754 932 957 920 48Z Travel 1,091 770 768 716 34$ PPL /b Total 790 253 357 417 47Z Travel 322 177 200 240 25Z La Subject Matter Specialists. Lb Field Extension Workers. Sources Ministry of Agriculture and Bank Staff estimates. The estimates are for permanent workers 'only and are unweighted averages across regions. with the exception of 19't0/91. The budget for total allowances per PPS for 1991/92 is 48 percent balow expenditures in 1985/86, and for travel the budget 40/ ARM SAR Annex 7, Table 2(b). 41/ Including 'ialaries, sapplies, and travel costs. - 68 - is nearly 35 percent below expenditures in 1985/86. For PPLe, similar trends are apparent. The implications of these data are confirmed by arecdotal evidence from farmers, who report infrequent and unpredictable field visits by extension workers. 4.21 Substantial expenditures affecting agricul;ure have also been made off-budget, primarily through subsidized liquidity credits frqm Bank Indonesia. By far the largest component of off-budget financing is credit to BULOG for rice procurement and maintenance of stocks (Rp 2,570 billion committed in 1991). In January 1991, the Government eliminated most liquidity credit programs in most sectore (however, see Box 4.2). Although not all the programs for Agriculture (Table 4.8) were eliminated, interest rates were increased dramatically, from 6 percent to a range of 16-18 percent. These rates are still below market levels,42/ but they are significantly positive in real terms, which has forced borrowers under all these schemes to improve efficiency. Table 4.8: LIQUIDITY CREDITS TO AGRICULTURE (Rp billion) New Total Outstanding Commitments for 1991 as of December 1991 BULOG (Food stock) 2,570 2,005 TRI (Sugar) 251 135 KUT (Food crops production) 205 88 Fertilizer 45 27 Cloves 760 852 Estates 2.350/a 2,927 Total Liauidity Credits (Agric.) 6.181 5.812 Memo: Total Liquidity Credits (all sectors) - 14,810 Total Credit to Agriculture Lb 14,824 8,465 Total Credit (all sectors) lb 154,182 113,808 la Eetimated. lb Includes Liquidity Credit. Sourcet Bank Indonesia, BRI and Batik staff estimates. 42/ As of November 1991, commercial lending rates were in the range of 26-32 percent. The KUPEDAS program which lends money to small borrowers in rural areas on commercial terms, has an interest rate of 32-33 percent. - 69 - Box 4.2: CLOVE MARKETING AND THE COSTS OF INTERVENTION In the case of cloves, the monopoly arrangements have largely benefitted a consortium of private traders at the expense of farmers, consumers and the central bank. The consortium-backed by Rp 760 billion in subsidized Government loans-set out to double the price paid to clove farmers while also doubling the price charged to cigarette manufacturers (the main users). As expected, the new price structure increased supply from farmers and decreased demand from consumers, in a market that already had large clove stocks. The consortiun. could not defend the floor price, and most farmers now receive prices no higher (and in many cases lower) than the prices prevailing before the monopoly was granted. In early 1992, the consortium requested a rescheduling of its subsidized loan payments. Recent modifications will do little to rectify the underlying problems with the clove monopoly. The changes largely involve passing on the responsibility for clove procurement and stock management to cooperatives and reducing the floor price paid to farmers. But the consortium retains the exclusive right to sell cloves to cigarette companies, and it has reserved the right to sell its existing stocks (enough for 2 year's of domestic consumption) before acquiring new stocks. Meanwhile, the cooperatives will be required to purchase and store cloves produced by farmers over the next two years (at an estimated cost of Rp 1,000 billion), with little or no scope to sell them. The new arrangements will cause a heavy debt burden for the cooperatives, which could lead to bankruptcy in the near future. 4.22 Chanaina Expenditure Priorities for the 19909 and Beyond. As argued throughout this report, the role of agriculture in the Indonesian economy is changing. Over the past twenty-five years, the Government has relied on the agricultural sector primarily to provide basic foodstuffs, which in practice has meant an emphasis on irrigated rice in Java, and this strategy has proven broadly effective. The rapid growth in rice production contributed to dramatic declines in poverty. For the future, maintaining rice self- sufficiency on trend will remain an important objective, but further poverty reduction will require increased attention to non-rice crops, as will the changing tastes brought about by higher incomes in most parts of the country. 4.23 UInfortunately, the current structure of public expenditures on agriculture does not support diversification of the agricultural sector. Rapid diversification into non-rice crops, livestock, fishr-ies, and processed products will require much greater attention to research, extension, and infrastructure. This section discusses the reprogramming of public expenditures necessary to ensure that a diversified agricultural sector can play the best role possible in the economy. 4.24 Envelons for Public Expenditures on ARriculture. For the purpose of projecting future resource availability for agricultural expenditures, it is assumed that the "expenditure ratio" for agriculture will remain at its 1990191 level of 0.32, while the ratio of total public expenditures to GDP is assumed to be 19 percent, the average for the second half of the 1980s. Agricultural GDP growth is projected to grow at about 3.0 percent for the next decade, while total GDP is projected to avers.ge 6.0 percent. Based on these assumptions, the expected "envelope" for agricultural expenditures is shown in Table 4.9 4.25 The issue is how these resources should be allocated to best serve the agriculture sector. Within agriculture, there is scope for major decreases in expenditures on some items, and relatively small increases in other categories. This would result in a net savings compared to current - 70 - Table 4.9: PROJECTED EXPENDITURES ON AGRICULTURE (Rp billion, 1990/91 terms) 1990/91 1992/93 1995/96 2000/01 Agriculture expenditures /a 2,602 2,730 2,920 3,400 As Z of - Ag. GDP 6.3 6.2 6.1 6.1 - Total Expenditures 6.7 6.3 5.8 5.0 - Total Development expenditures /b 14.4 13.6 12.5 10.9 /a Development plus routine; includes fertilizer subsidy. /b Ag. Development Expenditures as percent of Total Development Expenditures. Source: World Bank Staff Estimates. levels. A major issue is whether some resources, currently planned for agriculture, should be directed towards the non-agriculture sector or rural development, such as infrastructure. Such investments could yield higher returns for agriculture than some components of existing publio expenditures on agriculture. 4.26 Programs Requirina Increased Expenditure. There is little question that expenditures on research are too low and should be increased substantially. Maintenance of rice self-sufficiency will hinge upon research in newer varieties such as hybrids (para. 3.27 and Appendix I, Volume II). Conducting effective research on non-rice activities to support a more diversified agriculture will be more costly for many reasons. Most research to date has focused on a single homogeneous farming system, namely monocropped irrigated rice. The target area has been mostly Java and fairly compact areas of Sulawesi and Sumatra, and a very high percentage of researchers are etationed on Java. By contrast, effective research on non-rice activities will require not only a broader range of skills, but also a more regionally oriented research infrastructure. -To meet the challenges of supporting diversified growth, increased attention will have to be paid to improved management and institutional reforms (paras. 4.37-4.44). Assuming these changes can be effected, expenditures on research should be increased by about Rp 125 billion, to three times its current level, providing management of programs and resources is improved. 4.27 Expenditures on extension should similarly be increased across the board. Increased expenditures are needed not to hire more extension agents (which already number over 30,000 but for better training and for increased allowances for travel, extension materials etc. Rice has received most of the attention to date and extension skills are much less well developed for other food cropo, estate crops. fisheries and livestock. The ongoing Integrated Pest Management (IPM) lroject has been extremely effective at teaching farmers a wide range of farming skills, and many IPM techniques could be adopted by - 71 - the extension system as a whole. Improved management leading to a more professionalized extension service (paras. 4.45 and 4.46) could justify an increase in development expenditures of about Rp 35 billion (200 percent) from current levels. The increase would be reflected in the budgets of the various directorates, through which extenuion is financed. The routine budget will also need to be increased substantially. 4.28 Expenditures on irrigation O&M are also low. The Government is now implementing a program of efficient O&M, in conjunction with a policy to give a greater authority (and financial responsibility) to water users association. Assuming that this program is effective, O&M expenditures should be increased by Rp 80 billion (about 75 percent) over current levels. Over the medium- term, the Government should be able to recover much of this through its irrigation service fee (ISF) program. Farmers themselves should then begin to pay for and undertake O&M directly. Over the longer term, consideration should be given to beginning to recover some of the capital, as well as the other costs, of the irrigation network. 4.29 Areas for Expenditure Decreases. The increases in expenditures on research, extension, &nd irrigation O&M (totalling about Rp 240 billion) can be financed within the existing agriculture resource envelope. Paras. 4.10 indicated that expenditures on the fertilizer subsidy have very low returns. Recognizing this, the Government has already committed itself to phasing out the subsidy over the next few years. This alone would save about Rp 700 billion, more than twice as much as is needed to fund the incremental expenditures on research, extension, and irrigation O&M. In this context, research on optimization and rational use of fertilizers under regional conditions deserves high priority. 4.30 With respect to new irrigation develoDment, the fact that economic returns to such investment are low is a signal to reduce investment from currently high levels. The Government has been reluctant to do this because of concerns about maintaining rice self-sufficiency. However, Section III estimates that the new irrigated area needed can be developed by completing works in existing command areas, which cost less than one-half the amount of developing new command areas. It should, however, be noted that not all of the unused command area outside Java, can be developed because of soils, terrain and hydrological constraints. Assuming that about 35,000 ha of existing command area is completed each year, expenditures on irrigation development could be reduced by Rp 400 billion per year, or by about 75 percent of 1990/91 levels. If it is assumed that about 50,000 ha would be developed each year, expenditures would be decreased by Rp 340 billion per year. This does not, however, preclude the potential for groundwater development by the private sector, which needs to be realized.43/ 4.31 With the increase ln funding of irrigation O&M, the requirements for costly rehabilitation should also decline in the longer term. Although there currently is a rehabilitation backlog, unit costs for rehabilitation are far too high and/or rehabilitation works are over-designed. The costs could be 43/ "Indonesian Rice Policy: The New Challenges", David Seckler and Steven Tabor, report prepared for BAPPENAS, May 6, 1992. - 72 - decreased by one-third without substantially reducing system performance. Assuming that the pace of rehabilitation accelerates but that unit costs are reduced, overall expenditures could decline by an estimated 20 percent, or Rp 20 billion per year. 4.32 Expenditure savings from thc fertilizer subsidy and reduced irrigation expenditures would thus be about Rp 1.1 trillion per year, compared with increased expenditures of only Rp 240 billion on research, extension, and irrigation O&M. This would result in a net *surplus" of Rp 770 billion if the expenditure reallocations were done imdiately. Assuming that they are phased in over the next several years, however, and assuming that expenditures on other areas grow at above 3 percent per year, this woald leave about Rp 1.1 trillion in "unallocated" funds by 1995/96, Increasing to about Rp 1.33 trillion by the year 2000/01 (Table 4.10). Now ohould these extra funds be allocated? Table 4 10: CHANGES IN ALLOCATION ZY AGRICULTURAL EXPENDITURESt 1995/96-2000/01 (Rp billion 1990/91 terms) 1990/91 1995/96 2000/01 (Actual) Total la 2,473 2.800 3!250 New irrigation 510 :20 Lk 120 Irrigation 0&H 107 190 190 Irrigation Rehabilitation 200 160 160 Fertilizer subsidy 700 0 0 Research 78 200 230 Extension 18 50 60 Other 861 1,000 1,160 (Surplus) (--) (1,080) (1,330) /a Development expenditures only, which are assumed to be 96Z of total including routine. Lk If in lieu of 35,000 ha p.a. of new Irrigation, abo4t 50,000 ha are developed each year, this would entail expenditures of about Rp 170 billion. Source: World Bank Staff estimates. 4.33 The development of infrastructure-road., ports, electricity, communications, etc.-has played a major role in the rapid expansion of the economy over the past two decades. Good infrastructure reduces input costs, helps integrate markets, and enhances factor uobility (especially labor). Several studies have shown specifically how infrastructure development has - 73 - been a major factor in growth in agriculture and in the rural economy on Java.44/ It will be important to ensure that infrastructure development In the years ahead be supportive of emerging areas of growth in the agriculture sector. 4.34 In the past decade, a large proportion of infrastructure expenditure was directed toward Java. Given Java's population density, its rate of urbanization and industrialization, and the importance of rice production, this strategy was reasonable. However, at least from the point of view of agriculture, future growth will require more focus on infrastructure development in upland areas and the Outer Islands. Such development projects could entail deforestation, the sources and costs of which are discussed in Box 6.1 and these will need to be minimized. 4.35 Infrastructure development will also be more important to emerging agricultural activities than it was to rice. The quality (hence profitability) of many perishable horticultural crops is extremely sensitive to the time it takes for uhe product to get to the market or processor, and also to the handling of the product along the way. Livestock can lose substantial weight in transit from grazing areas to slaughterhouses. Good roads and ports are therefore essential. Proper processing of many -ommodities often requires constant refrigeration and careful quality control, both of which demand reliable supplies of electricity. Final markets are often located far from the production areas-often abroad-and making good planning and marketing decisions may require frequent contact with buyers, and therefore good telecommunications facilities are needed. 4.36 Consequently, it is critical that "surplus" resources in the agricultural expenditure envelope be targeted to infrastructure development programs. While these resources would not be controlled directly by the Ministry of Agriculture, the Ministry should take an active role in helping to identify the areas in uplands and the Outer Islands where roads, ports, power, and telecommunicatiors facilities are needed. An approach may be to utilize these "surplus" resources for poverty alleviation and regional balance, as needed for the Eastern Islands. Ihis could entail investments in infrastructure or in other economic activities (including agriculture), as identified to be critical for the development of the local economy. Over the longer-term, investments in multi-purpose water storage dams could become crltical, and these could be treated as part of infrastructure development. It might be appropriate to not spend these resourceo at all and instead use the savings to contribute to macroeconomic stability. Research and Extension - Ortanizati2n. Manaaement and Prioritle 4.37 Future agriculture sector strategies should deal with reseaech, extension and adoption of economically viable technology as a package. The concentration of extension activities in the provincial administrative structure under the Ministry of Rome Affairs requires more efficient coordination between AARD, extension organizations and farmers. While GOI is 44/ See, for example, "Employment Trends in Lowland Javanese Villages," Bill Collier et al (Mimao), April 1988. - 74 - presently thinking about coordinating AARD (research) and extension, this linkage will need strengthening, particularly at the provincial and local levels. AARD and the extension organizations are public institut_ons entrusted to deliver viable technical packages to be adopted by the farmers (private seator). Agricultural inputs, i.e., seeds, agrochemicals (including fertilizers and pesticides), machinery and agro-industry needs are provided through a mixture of parastatal, government and private sector entities. The following is an examination of the roles of these entities with a view to maximize their efficiency and contribution to the agricultural transformation process. Research 4.38 During the colonial era, agricultural research was limited to tree crops, sugar, herbs and spices. Following independence increased attention wao devoted to food crops, particularly rice, in order to combat famine and lessen dependence on imported rice. The timely establishment of IRRI in 1960 and development of IR8, provided Indonesia the means to achieve rice self- sufficiency in 1984. Although the green revolution included other commodities, such as wheat and corn, Indonesia benefited only from rice technological advances. 4.39 In the case of research development, international and bilateral donor assistance to Indonesia has primarily focused on creating an organizational research set-up responsive to the country's needs and resulted in the establishment of AARD in 1974. However, AARD's ability and flexibility for change have to im)rove if timely response to the needs of farmers, processors and consumers (in domestic and export markets) is to be provided. MARD has to demonstrate its ability to handle management, planning, MIS, priority planning, human resource development, budgeting, responsiveness to research clients, producers as well as consumers. Since AARD is the leading agricultural research agency, other entities involved in agricultural research, e.g., universities, other GOI institutes and the private sector would look for AARD's guidance, a role which AARD should continue to foster, develop and earn. 4.40 Achieving sustainability of agricultural development and balanced management of natural resources will be the top priority for Indonesia. Foremost among these natural resources are land, water and forests. Java is blessed with fertile soil, -1equate water resources but population pressures are increasing and stretching resource use to near maximum limits with present technology. Recent research evidence indicates increased degradation of the paddy environment with intensive cultivation under irrigated conditions. Although food security may remain a goal, researchers need to concentrate on sustainability of these land -esources, in addition to efficient water management, soil conservation, control measures for soil erosion (Box C.2), improvement of soil fertility ane rost-harvest technologies- 4.41 Increasing cropping intensity has been an effective way to expand production from the available cropped area. However, with the exception of areas where permanent water supplies are available, increasing crop intensity through irrigation, particularly in the dry season, is becoming an expensive investment (paras. 3.7-3.15). This is compounded by the ir- sased demand for - 75 - water from competing users who are starting to express their rights to this resource. Research on rice varieties with less water needs, water management techniques with more efficient delivery of water to plants, and drought tolerant crops should be on the priority list for research work. Environmental considerations and judicious use of the'natural resources need to assume a primary focus on the research agenda. In this respect ecoregional research needs to be strengthened and regional research efforts should be tailored to regionally available resources. Technology transferred from abroad should continue to be tested and modified for adaptation under Indonesian conditions. IRRI's f--ture research programs in rice are still directed to intensively cropped areas where irrigation and other farm inputs are available. Research in rainfed areas would be left to Indonesian scientists at the different and variable ecoregions of the archipelago. 4.42 As for commodity research, assurance of continued self-sufficiency in rice can be attained through introduction of hybrid rice and new varieties developed through both conventional and non-conventional means, including biotechnology and changing plant architecture (para. 3.27). Varietal improvement needs to be conducted with a two-pronged approach involving plant breeding and crop management. There are also environmental benefits from decreased pesticide use, and with the adoption of IPM systems, there is little loss in production. Maximizing the economic returns from fertilizer use should also be a priority research area. In this connection, planting suitable leguminous crops in the rice rotation can halt the degradation of paddy environment under intensive cropping systems. Corn improvement programs need to be vigorously pursued and be linked with crop utilization in feed and other agro-industrial purposes. Whether planting sugar cane in rain.ed areas is viable or not should be settled and efforts to maximlne economic benefits from this crop under Indonesian conditions should be intensified. Increasing sucrose levels through varietal selection and improved crop management deserves another effort in spite of the disappointing results obtained under NES sugar project (Loan 2344-IND). Pests affecting herbs and spices may pose problems for Indonesia. For example, the recent surge of Indonesia's vanilla exports could be threatened if the phytophthora fungal disease is not controlled. Quality of horticultural crops needs improvement to meet increased demand by affluent consumers in selected segments of domestic urban markets and for export. Research on the provision of more and better forages for the growing livestock sector will be increasingly important. Research on fisheries stock assessment and management, aquaculture feed research and control of aquaculture diseases, requires further strlengthening. Commodity research needs to be undertaken in the context of farming systems, based on agro-ecological zones. 4.43 As for the oraanizational aspects of research, AARD should continue to upgrade its information technology, particularly the links between its regional research programs and more importantly with other IARC's and other research organizations, in addition to IRRI and the International Service for National Agricultural Research (ISNAR). Whether improved high yielding cassava cultivars and hybrid pigeon peas developed at IITA (Ibadan, Nigeria) and ICRISAT (Hyderabad, India), respectively, are of value under Indonesian conditions, needs further research. The increased role of biotechnology in agriculture adds another dimension to modernizing Indonesia's research - 76 - programs, particularly the importance of networking and screening technologies which might benefit Indonesia's agriculture. 4.44 Although the CGIAR has indicated that the genetic trassfer of natural $ones would not be subject to propriety rights, the same cannot be said for synthetic genes or similar developments in the private s.ctor. Propriety rights are increasingly becoming a factor in transfer of technology not only generated by the private sector, but also for public research institutions end universities which establish their own privately endowed development foundations. If GOI is to capitalize on new biotechnologies, it must prioritize itg investments in human resource development in that growing but relatively expensive research undertaking. The continuum of basic and applied research is increasingly becoming more interlinked. Research extension linkages in Indonesia, except for rice, have been generally poor. In an environment of budget constraints, new organizational approaches are needed to assess new technologies and adoption by users. Therefore, the development of a lean, responsive AARD needs to be the primary goal of GOI. Extension 4.45 lank involvement in extension and training activities started in the early 1970.. These efforts were instrumental in delivering an economical intensification package for the BIMAS program followed by INSUS and SUPRA INSUS. A decentralized approach based on provincial and regional resources should be fostered. Skills improvement, and greater use of modern communications technology as part of the outreach service to farmers, should be undertaken. 4.46 The following should help clarify future uirections for extension: (a) Future prices of primary agricultural commodities may decline in real terms and prices of inputs may increase. Consequently, efficient technical recommendations should be based on improved high yielding varieties, including hybrids, and better crop management practices, particularly in the use of pesticides and fertilizers. (b) Returns to off-farm employment are likely to increase more rapidly than earnings in agriculture. An efficient allocation of labor resources, therefore, implies a declining relative share of employment In agriculture (paras. 6.17-6.19). Thus, labor saving mechanization may become a viable option for certain operations particularly in land preparation, seeding, application of agrochemicals, harvesting and threshing (para. 4.66). (c) Farmers' training programs should help implement knowledge intensive programs, such as IPM, at the local level. (d) Lack of Subject Matter Specialists (PPS) for crops other than rice Is hampering delivery and testing of viable palawija production packages. Therefore AARD regional staff may have to provide this technical backstopping, which would provide valuable feedback from farmers to research programs and thereby strengthen research- extension linkages. Some AARD staff, particularly at regional food - 77 - and tree crops institutes and centers, are already acting as PPS. This should be encouraged and recognized by AARD and provincial administrations. (a) Extension recommendations and physical infrastructure should be tailored to provincial needs farmers' educational levels and regional and farmer resource endowments. (f) AARD and extension staff have to demonstrate jointly through a simple and efficient monitoring and ey#luation program that recommended technical packages are ec9pomically viable and contribute to increased not farm income. The separation of accountability between AARD and extension agencies does not serve the farmer who is the ultimate adopter and risk taker. Enhancing the Role of the Private Sector 4.47 Production of agricultural commodities is dominated by the private sector, i.e., a multitude of farmers and smallholders. However, the Government has had a major role In organizing t1le distribution of (and subsidizing) certain inputs and outputs, defending floor and ceiling prices for certain crops (Section V) and research and extension. In addition, state- owned enterprises have had monopolies over the import and domestic marketing of many processed food products. Although the robust growth of the agricultural sector over the past decade is evidence of a broadly conducive public sector role, conditions in the sector hqve changed dramatically since the 1970.. The Government is begimning to re-ex<=ie the role of the public sector to ensure that it focuesses it resources on activities that support the new patterns of growth expected in the 1990. and beyond. 4.48 Production and Employment. About 98 percent of total agricultural value addad and employment has been generated by the private sector. Virtually all food and farm non-food crops are produced by the private sector. The Government has had a minor role in livestock and fishery production, contributing to less than 1 percent of value-added. The only major role of the Government in production has been In plantation-based estate crops. This public role is a relic of the nationalization of foreign-owned estates (mostly rubber) in the 1950.. Some public estates (PTPs) also produce sugar, tea, coffee, cocoa, and a few other minor crops. 4.49 In the early 1980e, PT?. accounted for about 60 percent of value added in the estate crop subsector. During the mid and late 1'30s, however, private-sector investment-especially in oil palm-grew rapidly. At the same time, PTP investments slowed due to financial and implementation problems. Consequently, the private-sector share of estate crop production rose to about 55 percent by the end of the decade. Although the Government has been reluctant to privatize the PTP?. it has begun to encourage PTPs to enter into joint ventures with the private sector as a means of improving management and getting access to financing. Given the pace of private investment in the subsector, the private sector share of value added can be expected to rise to about 75 percent by the mid-1990. - 78 - 4.50 In the smallholder tree crop subsector, the Government is not directly responsible for production, but it has provided credit and intensive extension packages to about 300,000 farm families over the past ten years. While on the whole this program has dramatically boosted incomes of beneficiaries, only about 15 percent 45/ of tree crop smallholders have been directly reached under Government projects. The success of these projects has had a strong demonstration effect, but extension to non- participating farmers-even near project areas-has been weak. High priority shou'i be given to experimenting with pilot schemes that would provide good planting material (on a cash basis, over a longer term) and strong extension support to the large number of, heretofore, unassisted smallholders. 4.51 Provision of Inputs and Narketing of Outputs. One of the primary instruments for Government intervention in the sector has been BULOG, the National Logistic Agency (para. 5.21). Increasing affluence over the years has meant that an estimated 50 percent of civil servants cu-!rently sell the rice rations they receive from BULOG to purchase higher quality rice on the market. The price received by the civil servants for this rice is often only 60 percent of the cost to the Government of delivering the rice. This is an extremely inefficient way to provide an income supplement to civil servants, especially in the context of well functioning markets for rice. These and other factors discussed in paras. 5.26-5.30) have led BULOG to reassess its role in the rice market for the 1990s. The Government has already begun to widen the "band" between floor and ceiling prices, and there have been proposals to replace physical rice rations with a cash payment. This could be implemented initially in the "rice-surplus" provinces, and then subsequently in all provinces. In conjunction with these moves, BULOG could begin leasing out its excess storage capacity to the private sector. There is also little rationale for BULOG to maintain its monopoly over commodities such as sugar, soybean, wheat (a detailed discussion is included in Section V). 4.52 Research. International comparisons suggest that Indonesia may have substantial scope for increasing private sector involvement in research (Table 4.11).46/ In 1985, the private sector accounted for only about 3 percent of total research expenditures in Indonesia. Pakistan and Bangladesh also had similar levels of private sector expenditure, with India slightly higher. By contrast, the private sector accounted for 19 percent of expenditures in Malaysia, 38 percent in Thailand, and 39 percent in the Philippines. In more developed countries such as the United States, the private sector accounts for nearly one-half of total research expenditures. 4.53 AARD is experiencing budget constraints and has indicated genuine interest in private sector support for its research programs. Presently private sector involvement in research could be described as a wait and see attitude. Therefore AARD has to prove its relevance to private sector 45/ For more details, see Indonesia: Stratefies for Sustained Develonment of Tree Crops, Volume 1, World Bank, December 7, 1989. 46/ The following sections on research rely heavily on Dina L. Umali, "Public and Private Sector Roles in Agricultural Research: Theory and Experience," World Bank (mimeo), September 1991. _ 79 - Table 4.lii PRIVATE SECTOR EXPENDITURES ON RESEARCH IN SELECTED COUNTRIES Total Research Expenditure Per.ent Country ($ million) private Indonesia 64 3 Pakistan 31 3 Bangladesh 30 3 India 265 6 Malaysia 55 19 Spain 118 21 Thailand 11 38 Philippines 11 39 United States 4,038 47 Source: Umali, Dina L. "Public and Private Sector Roles in Agricultural Research: Theory and Experience, World Bank (AGRAP) mimeo, September 1991. interests and the following stages could pave the way for more private sector participation: (a) AARD should create a private sector liaison unit attached directly to the DG office with responsibilities to screen AARD research findings, priorities and research programs relevant to private sector interests. This AARD internal exercise should be coupled with a fact finding campaign to assess private sector needs, its articulation and design of research proposals and contracts to implement agreed research programs. Members of such a private sector unit should be business oriented persons with vision, solid scientific background, good reputation and be paid from a special private sector development fund for that purpose; (b) AARD should demonstrate its ability to execute contracts with private sector In a business-like fashion; (c) AARD should realize that private sector entrepreneurs prefer turnkey contracts with foreign suppliers of imported technologies and equipment particularly in agro-industries, e.g., poultry, fruit juice packaging, etc. AARD's comparative advantage may first lie in development of Indonesian commodities for domestic markets and second for export markets; (d) AARD linkages with other research entities should be strengthened, e.g., universities, other institutes, private laboratories; and - 80 - 'e) AARD should strengthen its legal mandate to acquire relevant technology of propriety nature to be included in its own research continuum of basic and app.'lid research programs. 4.54 The aforementioned steps are not exhaustive but indicative of the trend that AARD has to undertake if it is to assume the leading role of delivering relevant technical packages to the private sector, including its original clients, i.e., farmers and producers of primary commodities. Private sector participation in supporting agricultural research programs cannot be decreed but must be convincingly demonstrated by AARD. Thereafter, financial contributions from the private sector could become a reliable source of operational support. The creation of a research endowment foundation has been promoted but AARD has to demonstrate its efficiency beyond achieving rice self-sufficiency. 4.55 Inputs. Adequate provision of inputs in a timely manner at economic prices is becoming increasingly crucial to efficient agriculture, particularly with increased globalization of markets and decreased provision of subsidies. One of the important pillars for the success of the BIMAS programs was provision in kind of subsidized seeds, pesticides, fertilizers and irrigation water. The recent removal of subsidies for pesticides and fertilizers (by mid-1990s) and GOI deregulation packages for private sector involvement in provision of inputs is encouraging. However, the phasing out of public sector from commercial activities has to be judged in view of ability and willingness of the private sector to increase its role in provision of agricultural inputs. Fortunately, the private sector participation is being encouraged by the Government. 4.56 Seeds. To introduce improved high yielding rice varieties, GOI established a seed board and seed companies to multiply and distribute improved seeds at subsidized prices within the context of the BIMAS program. Similar programs for corn and soybeans and even tree crops were adopted. Bank and bilateral donors supported GOI efforts in that direction with investments in physical facilities and organization of seed multiplication and distribution channels. A seed law was enacted in 1971 and is still in effect. Private sector involvement was primarily limited to corn, particularly for hybrids (C-1) where built in pzutection is guaranteed. Three major private multinational corporations were involved in corn seed production but presently only two of them are actively involved. Seed subsidils were also extended to soybeans particularly for planting in outer islands. Importation of horticultural seeds and propagation material is presently undertaken by the private sector with little value added to the local economy. 4.57 Wt:h the change of economic environment, GOI is realizing that to effectively involve the private sector in seed production and marketing, several measures need to be undertaken. Foremost among these are the gradual removal of subsidies and enactment of a seed law and policy guidelines conducive to further private sector involvement. A master plan for the development of seed industry is needed. 4.58 During the transition period, as the private sector gears up for greater involvement, GOI is expected -o remain involved in seed production and distribution of self-pollinated crops except hybrids, as well as in ensuring - 81 - quality of seeds and planting material. GOI should take a closer look at its commercial-oriented operations in broeder seed (basic seed) and loundation seed production and reach a breakeven point of cost of production and marketing. GOI should resist the temptation of subsidizing inputs to promote production of certain commodities except in special cises where new technology packages are to be introduced on on experimental basis. AARD should intensify its varietal development efforts and breeding programs to produce new varieties suitable for ecoregional zones and special production systems where economic benefits are apparent and private sector involvement is not envisaged, e.g., cowpea and mung bean development for acidic soils and drought conditions. Establishing active exchange of breeding material with other IARC's other than IRRI would strengthen Indonesia's agricultural r6search capability. As for rice, the speed at which hybrid rice is introduced will depend on enacting the right policies to involve private sector participation. Present parastatals could introduce hybrids on a commercial basis, but this has not proven viable in the case of hybrid corn. As for tree crops and nurseriee, many research institutes and field stations are involved in commercial production of aeedlings and closer examination to divest their interest in revenue generation activities is needed. Sustainable increases in smallholder production can be achieved by improving access to planting material. 4.59 Pesticidcs. The introduction of IPM measures in 1986-87 in rice 'roduction following brown plant hopper infestation provided a boost to biological control and the judicious use of pesticides. Removal of subsidies and farmers' continuous education and training played a significant role in naintaining growth in rice yields and decreased cost and use of pesticides. It also resulted in eliminating broad spectrum pesticides which controlled and eradicated beneficial predators. 4.60 The extension of IPM measures sLould be based on post management entailing: (a) cultural control, e.g., growing a healthy crop; (b) host plant resistance, i.e., use of resistant varieties; (c) biological control, e.g., preservation or encouragement of natural pest enemies; and (d) chemical control, i.oe., only an occasional use of pesticides when pest numbers are excessive. This is particularly important in Indonesia's tropical conditions where pest hosts are available all the year around and intensive cultivation is practiced. Use of pesticides for horticultural crops (fruits and vegetables) should be examined carefully as these commodities are produced in home gardens and consumed mainly in fresh form. The implementation of IPM measures is location specific and requires knowledgeable farmers. Therefore, IPM training should be given high priority within the context of an improved extension service slnce other crop cultural and management practices are also involved. 4.61 GOI has to establish a workable regulatory environment for pesticide use within the context of IPM. GOI has also to monitor vested interest and abuse by the private sector in pushing pesticides, which have adverse environmental and health impacts. e 4.62 Fertillzers. Indonosian farmers are using higher amounts of fertilizers, particularly for rice production, than other neighboring countries. Research experiments indicate that up to about 50-70 percent of - 82 - applied urea to flooded paddy is lost due to drainage prior to broadcast application and volatilization. Therefore, the use of slow release forms and organic manure should be explored. Research also indicates that more frequent applications with smaller dosages is needed. If broadcasting is to be continued, this would cause labor costs to increase. This adds argument for use of supergranulars of urea, banding method of application and deep placement and slow rele%se forms. Lately the use of essential microelements e.g., zinc and copper is being promoted to increase yields. 4.63 The aforementioned technical problems need resolution and verification at farmers' fields prior to requesting farmers to apply certain brands and formulations. Fertilizer companies could supply funding for such research. 4.64 The Government plays a major role in the production and distribution of fertilizer. Fertilizer imports are restricted and virtually all domestic production is done by public enterprises. The domestic urea industry is competitive, and in fact it exports a substantial portion of its production. The Government could consider privatizing the profitable urea factories. The domestic TSP and AS industries are less competitive, and the Government ought to consider stopping domestic production if world prices fall below local variable costs of production, for extended periods. 4.65 A state-owned company has a monopoly on the wholesale distribution of fertilizer. Preliminary evidence suggests that distribution costs aze at least 25 percent above what they would be under competitive marketing arrangements. The Government has now commissioned a study of fertilizer distribution and may consider allowing fertilizer companies to wholesale their output directly. In 1990, official cooperatives (KUDs) were accorded the sole right to retail fertilizer to farmers. Most KUDs are too poorly organized to carry out this function, however, and they transfer retail rights to the private sector for a fee. The Government ought to reconsider this monopoly arrangement. Before 1990, competition among private vendors in some areas allowed farmers to buy fertilizer at 3-5 percent below the official price. 4.66 Agricultural Machinery. GOI carefully balances labor substitution by agricultural machinery. Although machinery for paddy land preparation, harvesting and threshing ilave been in use in Indonesia, a more rapid introduction of labor-saving machinery has been discouraged for social reasons. However, the increase in off-farm employment and higher wages in agr'.culture is likely to increase mechanization. Use of small tractors, pumps, sprayers, harvesting and threshing equipment would increase. Restrictions on private sector manufacturing and marketing of such equipment should be relaxed. Use of dryers to reduce post harvest losses should be encouraged. An assessment of the impact of high wages on future mechanization and the impact of mechanization, if any, on the future size of land holdings, is an area requiring further study (para. 7.23). 4.67 With regard to the agro-processing development, in addition to the investments in infrastructure (paras. 4.33-4.35) and the trade and marketing policy reforms (Section V), there is also a need to deregulate land acquisition procedures, and accelerate land titling and registration (rox 4.3). - 83 - Boy. 4.3: REQUISITE ADJtISTMhINTS TO LAND POLICIES The current land policy framework relies on a large number of Government regulations (well over 500) which govern land allocation and pricing. These regulations tend 'o underprice land resources grossly, for instance, by charging prices that are less than 2: percent of market value for sales of stste land. Since these low prices produce a substantial amount of speculative demand, the Government has adopted a complex regulatory framework for allocating land. The process of implementing these regulations overburdens Goverrment agencies and delays land acquisition. Although the policy to grant rights of land exploitation only to Indonesian partners in joint ventures had discouraged foreign investors in erport-oriented agricultural activities, the July 1992 deregulation changed the policy to enable joint ventures to obtain such rights. The World Bank report I/ proposes a system of land resource allocation, which relies more on market prices, with a more indirect role of the Government for protection of the environment and for providing an enabling environment for the market to operate efficiently through collection and dissemination of information and registration of land right ownership. The report calls for adjustment._ to policies requiring a change in legal and regulatory framework (including a simplification of land regulations and, over a longer term, removal of restrictions on land lease periods and ownership of land rights), improving land Information systems, accelerating land registration/titling, and formulating a transparent resettlement policy at the national level, based on fair compensation. I/ World Bank, "Land Resources Management and Planning", June 26, 1991. - 84 - V. DEREGULATING PRICE AND TRADE REGIMES 5.1 Overview. This chapter examines the past an6 future role of price and trade policies in the context of changing government policy objectives. The GOI has embarked on a series of regulacory reforms since 1985. These reforms, as well as remaining import and export restrictions are reviewed. The existing protection structure for agriculture is compared with that for manufacturing. The variations within the sector, including the biases against export-competing commodities, are highlighted. The Chapter then reviews the policy trade-offs as posed by speci-ic commodities. High sugar prices, for example, tax not only sugar consumers and the agro-processing industry, but also consumers of other products who must pay higher prices because land is shifted into cane production. Sugar producers are also taxed by being forced to grow a crop which is less profitable than competing crops, particularly rice on Java. For several major commodities (rice, soybean and meal, sugar, cassava, wheat and flour), trade patterns, policy ob,ectives, resultant price and trade regimes, policy issues and future options are discussed. A box at the end of the Chapter evaluates the likely impact on Indonesian policies of the successful agricultural negotiations at the Uruguay Round. 5.2 Obiectives and Instruments of Trade Polic . Agricultural policy in Indonesia, like that in other countries, attempts to achieve a large number of objectives, These include low and stable food prices, agriculture and rural development, the development of value-added processing industries, and wider macroeconomic objectives such as employment generation, poverty alleviation, and saving (or generating) foreign exchange. These objectives are often competing and give rise to a multitude of policy instruments. As a result, the policy setting for agriculture is often more complicated than that for the industrial sector and is often more difficult to reform. 5.3 Indonesian agricultural trade has been highly regulated and, until recently, agriculture was also the sector least affected by the trade policy reforms of the past six years. The principal trade policy instruments are import licensing requirements, tariffs, and a variety of export regulations. The latter include bans, taxes, and licensing requirements which serve as informal quotas. Exchange rate policy also has a major impact on trade in agricultural products. 5.4 Import regulations are designed to meet two main objectives: to protect domestic producers and to provide price stabi. r to consumers. In the case of producer protection, the GOI is constrained by the fact that staple foods represent a major share of low- and middle-income household expenditures. As a result, prices for most staple foods are kept relatively close to world prices and support to farmers is provided through irrigation investment and various intensification packages which include advanced production technologies and subsidized inputs. There are only two primary commodities for which prices have been kept consistently high: sugar and soybeans. But there is the danger that protection will gradually increase (for example, recent attempts to reverse dercgulation of edible oil regime) and be extended to other commodities. This tendency often occurs with economic development. Governments feel the need to protect producers' incomes and consequently slow the transfer of resources out of agriculture and into - 85 - the industrial sector. At the same time, the direct political costs of a protectionist a*ricultural policy seem small because of the declining share of f2od in household expenditure. However, the hidden costs of such a policy are high and will remain so in Indonesia, which is likely to depend on labor intensive manufactures as a source of growth for the foreseeable future. 5.5 In practice, therefore, the principal objective of price policy for most commodities has been stability. Prices for a number of important food commodities are regulated through administered price systems. Under these systems, the GOI sets prices at various points of the marketing chain and also restricts marketing of the products to licensed distributors. These administered price systems operate under the umbrella of trade policy. Trade p3licy cannot be reformed without changing the admiristered price systems as well. 5.6 Another major objective of government policy has been the development of domestic processing industries both for import- and export- competing industries. This goal has been pursued primarily through the price system. For imports of processed agricultural products, trade restrictions have given rise to relatively high domestic prices and even higher effective protection. For exported commodities, the tendency has been to tax the primary commodity. The price regime that has resulted often times taxes those very industries which the country hopes to develop. 5.7 Recent Trade Policy Reforms. Over the past decade, the Government has embarked on a series of macro adjustments and regulatory reforms to stabilize the economy, to improve its competitiveness, and to reduce the dependence on oil as a source of export earnings. A significant part of the reform effort has been directed towards trade policy. There were major devaluations of the rupiah in 1978, 1983, and 1986; since 1986, the rupiah has been under a managed float. In 1985, the tariff structure was rationalized by reducing the ceiling on tariff rates, by reducing the number of tariff rates, and by raising the number of items with tariffs below 30 percent. The government also reorganized the customs service and placed many of its duties in the hands of a private contractor.47/ 5.8 An unfortunate by-product of the 1985 tariff reforms was the introduction of import licensing requirements (NTBs) on a large number of commodities. Commodities on the Government's "Restricted Goods List" can only be imported by those holding the proper type of license.481 In 1986, goods on this list represented 54 percent of domestic agricultural production and 68 percent of domestic manufacturing production (Table 5.1). A major part of the recent reform effort has aimed at reducing the number of commodities on AZ/ In 1986, the Government also introduced a duty-drawback scheme (BAPEKSTA) under which exporters can by-pass licensing restrictions and can import the inputs duty-free. However, a few agricultural commodities have been imported under this scheme. 481 All importers must hold a license to import. Holders of the "General Importer" license, which is the least restrictive license, may import any commodity not on the "Restricted Goods List." - 86 - Table 5.1: PRODUCTION COVERAGE OF IMPORT NTBs (1986-91) Mid- End- End- Early May June 1986 1987 1988 1990 1990 1991 Agriculture 54 53 41 40 39 30 Manufacturing 68 58 45 38 33 32 Mining, Oil & Gas 0.2 0.2 0.2 0.2 0.2 0.2 Economy-wide 41 38 29 28 25 22 Source: Bank staff estimates. this list. By 1991, the proportion of manufacturing production covered by NTBS had been cut in half to 32 percent. With the exception of 1988 when imports of a large number of minor agricultural commodities were liberalized, agriculture was relatively unaffected by early reforms. The reform package of 1991 was the first to really focus on agriculture and lowered the shere of agricultural production covered by NTBe to 30 percent. This was a major step in the right direction. Atricultural Import Licensin2 Regime in Transition 5.9 Licensing requirements have been a principal policy instrument for imported commodities. Most agricultural commodities on the "Restricted Goods List" can be imported only by BULOG, the National Logistics Agency, or by one of two state trading companies. BULOG holds the right to import rice, wheat, wheat flour, sugar, soybeans and cereal by-products. The July 1992 deregulation package eliminated NTBs on a number of minor cereals such as rye, oats, barley, and sorghum. State trading companies hold exclusive import licenses for the majority of other restricted agricultural products and for processed foods and beverages.49/ 5.10 With the exception of corn and soymeal, few changes have been made in the commodities controlled by BULOG. Corn was deregulated in 1989; soybean meal in 1991. For rice, sugar, wheat, wheat flour, and soybeans, licensing restrictions serve as adjustable quotas -which are used to regulate domestic prices. BULOG controls not only the international trade of these commodities, but also plays a significant role in the domestic marketing system as well. In the case of wheat flour and also soybean meal prior to 1991, imports have 49/ The state trading companies often sell the right to import their license to private traders. As a result, agricultural products are a very small part of their business. - 87 - bean negligible in order to protect the interests of domestic processing plant. 5.11 7he reform package of 1991 eliminated licensing restrictions for a large number of Important agricultural products and lowered the share of domestic agricultural production covered by mTBs by 10 percentage points over the previous yoer. Within agriculture, most of the remaining WT3 coverage is within the food crop. sector and covers those commodities handled by iULOG (Table 5.2). If rice imports alone ware liberalized, the agricultural TsNl 5.2s PRODUCT'ON COVERAGE OF AGRICULTURAL NTBS IN 1991 Percent of Production Agriculture 30 Food crops 56 Estate & other crops 14 Livestock 0.1 Forestry 0 Fishing 0 Manufacturing 32 Food, beverages, tobacco 60 Ecgnmv-wde 22 Sourcet Bank Staff estimates. production coverage of NTBs would fall from 30 to 9 percent. Other agricultural commodities which are still subject to licensing restrictions include pure-bred poultry for breeding, processed milk products (including milk and cream, powdered milk, butter and cheese), garlic and cloves. Milk is also subject to local content restrictions. Food, beverages, and tobacco are classified as manufacturing products. There have been few reforms in this subsector and in 1991, mTBs covered 60 percent of domestic production. Export Licensint Retime in Transition 5.12 Exported commodities have come under a variety of different types of export controls. These includet export bans, export taxes, and two types of licensing controlo. Exports of "regulated" commodities are limited to trader. "approved" by the Department of Trade or to a Joint Marketing Office (JMO) which is especially set up to market the commodity involved. JMOs were once prevalent in the case of estate crops and some spices. Commodities which are "supervised" can only be exported after approval of the Department of Trade and by agents appointed by the Department. Both the "regulated" and "supervised" licensing systems can serve as informal quotas on export - 88 - commotities. W.th the exception of export bans, the trade reforms of the past two years have substantially rodaced the number of commodities facing export restrictions. 5.13 Export bans are used to encourage the development of domestic processing industries, to protect natural resources, to preserve animal or plant species, and to raise the quality of Indonesian exports. Export bans affect low grade rubber and early-picked vanilla, raw skins and hides, raw and semi-finished rattan, logo, and a variety of unprocessed and semi-processed wood products. 5.14 Export taxes are now levied on only a few agricultural productes mixed grade pepper, palm nut, tengkawang seed, and leather. In the case of forestry products, there are prohibitive taxes on exports of sawn timber. 5.15 Approximately 45 percent of Indonesia's agricultural exports were at one time classified as "regulated" and were limited to "approved" exporters. The main objectives of this system are to limit competition among domestic exporters and to raise prices for those commodities in which Indonesia h6s significant market power on world market. The approved exporter system is also used to allocate quotas for those commodities in which Indonesian exports are restricted by import quotas in foreign markets--textiles and tapioca. The reforms of the past tswo years have eliminated most licensing restrictions of this type. The only products remaining under "regulated" exporter status are coffee, tapioca, textiles and textile products, processed wood products and rattan mats. 5.16 "Supervised': commodities can only be exported by appointed agents after the approval of the Ministry of Trade. The main purpose of this system is to ensure that domestic consumption requirements are met before a commodity is exported. Commodities on the "supervised" list include live cattle (horses, cows, buffalos, sheep and goat), some commodities under BULOG's control (rice and soybeans), kapok seeds, and fertilizer. In a major reform, vegetable oils were eliminated from the list in 1991. A detailed sequencing of trade reforms in the agriculture sector are included in Appendices E and F, Volume II. Protection in Agriculture Versus The Rest of the Economy 5.17 The net impacts of Indonesia's trade regulations and tariff structure on nominal (NRP) and effective (ERP) rates of protection are summarized in Table 5.3. Although the NTB coverage of domestic agricultural and manufacturing production Is now quite similar at about 30 percent, nomnFal protection for agriculture is half that of manufacturing, 6 percent compared with 13 percent. However, this masks considerable variation within the sector. Forestry products are taxed through a variety of export regulations while nominal rates of protection for livestock (due to tariffs) and food crope (due to licensing controls) are above the average. Within the food crop sector, NRPs for sugar and soybeans are well over 50 percent while those for rice and corn are close to zero. In spite of licensing controls, the price of rice has been approximately at parity with world prices during the last couple of years. - 89 - Table 5.3i STRUCTURE 0 PROTECTION IN 1991 (Z) Nominal Effective Protection Protection Rata Rate Agriculture 6 11 Food crops 11 18 Estate and other crops 5 13 Livestock 17 27 Forestry -38 -42 Manufacturing 13 57 -4, beverages, tobacco 16 190 rgtaA A ~~~~~~~~~~IA zxport cesputin sgriculture La -3 -3 Import comoetiub agriculture /a 13 23 ia Nominal and a; _ect.bve protection rates are for 1990 rather than 1991. Sourcet Bank St&i estimates. 5.18 The protection structure also exhibits significant escalation by degree of processing. The nominal protection rate for processed foods int he food, beverages and tobacco category is 16 percent, compared with 6 percent for primary agricultural products. This leads to effective protection of 190 percent for processed foods. The protection structure is also biased against export-competing agricultural commodities. Some export commodities are taxed directly by the system of export licensing cnntrols and have negative nominal and effective protection rates. Export commodities are also indirectly taxed by the fact that resources are drawn out of production for export and into the production of more highly protected import-competing commodities.5Q/ 501 The distortionary impact of this on resource allocation is probably small since the price elasticities of export demand for a number of Indonesia's export-competing products (spices and tapioca, for example) are quite smll. - 90 - Policy Trade-offs - Specific Commodities Rice 5.19 Trade. During the .970s, rice imports varied between 500,000 and 2 million t annually and rice was Indonesia's privcipal agricultural import. Indonesia was also the world's largest importer of rice. Since 1977, however, there hae been a dramatic turn-around in the trade balance. Rice production, which had grown by 3.5 million t over the eight years prior to 1977, grew by 10.5 million t over the following eight years. This was more than enough to meet growing domestic demand and rice was exported in both 1985 and 1986. Pollowing the poor harvests of 1987 and 1988, domestic consumption needs were met by drawing down stocks rather than by imports.51/ Surpluses during the next two years were used to rebuild stocks. 5.20 Policv Oblectives. A principal objective of the government's agricultural policy is food security. Because of the predominant role of rice in the food system, this objective has been pursued by policies to achieve rice self-sufficiency and to maintain rice price stability. The principal policy instruments are various rice intensification programs (BINAS, INMAS, and SUPRA INSUS) which provide farmers advanced technologies and subsidized inputs5 rehabilitation and expansion of irrigation systems; an administered price system which sets the price of rice relative to those for fertilizer and other commoditiest and a food price stabilization program. 5.21 Price policy Is implemented by BULOG, the National Logistics Agency. BULOG was establiohed in 1967 at a time when marketing channels were severely disrupted and the transportation system and other marketing infrastructure were in disrepair. BULOG has the sole authority for importing/exporting rice and is also responsible for: (a) the distribution of rice to the Armed Forces and Civil Servants (Budget Groups); (b) a national rice reserve stock for emergencies and to stabilize inter-annual fluctuations in rice prices; and (c) a national buffer stock to stabilize inter-seasonal fluctuations in rice prices. Rice distributions to Budget Groups amount to 1.6 million t annually and an additional stock of approximately 1.0 million t is thought nece3sary for BULOG's price stabilization functions.52/ In practice, it is impossible to SI/ The small imports of recent years were classified as in-kind repawments of rice loans. 52/ Timmer, C. Peter, "Indonesia's Experience with Rice Market Interventions," Indonesian Food Journal, No. 1, Vol. I, BULOG, 1989. - 91 - distinguish between stocks held in the national reserve and buffer stocks for Inter-seasonal price stabilization.5_/ 5.22 Domeatic Prige he_gime. The Government sets an annual floor price for producers and a ceiling price for co-sumers. BULOG insures that prices fall within the price band through its procurement and distribution of rice. Procurement and distribution are handled by 27 DOLOGS, one for eaec province, and by 94 district units (sub-DOLOGs). The sub-DOLOG. are located throughout the archipelago in both surplus and deficit a_as.a4J/ BULOG also has a nationwide storage capacity of about 4.6 million t. Over half this capacity is government-owned. 5/ 5.23 Until recently, BULOG was very successful at stabilizing market prices and at keeping them within the floor and coiling price. The coefficient of variation of the Jakarta wholesale price for Saigon Bandung I Was 12.6 percent during the years 1969 to 1987 compared with 42.4 percent for the price of Thai 5 percent brokens.54/ At the same time, BULOG has kept its domestic procurement to under 10 percent of domestic production (Annex III, Table 3.5, Volume II). Although domestic procurement has ris.'n consistently over the years, the amount of rice entering commercial marketing channels has also risen substantially.AI/ When measured against production, therefore, procurement by BULOG and by the private sector can both rise over time. 5.24 The margin between the ceiling and floor price narrowed considerably during the 1970s, but has trended upwards in recent years (Annex III, Table 3.4, Volume II). The latest increases were partly due to BULOG's inability to defend a lower ceiling price. Stocks had reached all-time lows following the drought in 1987. BULOG was unable to distribute .nough rice to prevent prices from rising. The burden of stabilizing prices was transferred entirely onto BULOG stocks (and the budget). The problem is exacerbated if BULOG must purchase rice for Budget Groups at a time when domestic supplies are short. According to Ellis,54/ "BULOG had been transformed from a price- guided stabilization agency to a target driven procurement agency." 5.25 In the early 1970s, rice prices were kept below import parity and rice cons-.mptlon was subsidized. However, this also resulted in a tax on producers and the Government gradually raised prices to eliminate the tax. Higher rice prices also had a favorable impact on other Government policy objectives &uch as employment go, tion and poverty alleviation in rural areas. Since the mid-eighties *sonesian prices have been at or above world 53/ Stocks can be classified in a number of different ways. The above classification was chosen in order to distinguish between inter-annual and inter-seasonal price stabilization. 54I Ellis, Frank, "Future Rice Strategy in Indonesia: Rice Self-Sufficiency and Rice Frice Stability," Indonesian Food Journal, No. 1, Vol. I, BULOG, 1989. 551 Atmaja, Sukriya, Sugeng Amat and Mulyo Sidik, "The Role of Bulog in the Indonesian Economy." Indonesian Food Journal, No. 1, Vol. I, BULOG, 1989. - 92 - parity and the objectives of Government price policy are lees clear 4j/ SWMOG stock levels may have had an overriding influence on price policy in recent years. After stocks fell to an all-time low following the poor harvests In 1987 and 1988, prices may have beest allowed to rise in order to Increase stock levels. 5.26 Pollcy Issues and Future O2tions. Of BULOG's three stock-holding responsibilities, only the national reserve stock is central to food security. The distribution of rice to Budget Groups involves unnecessary marketing costs since rice delivered to these Groups is often re-sold on the domestic market at prices well below the Government's cost of delivery. The program also has a destabilizing impact on prices if BULOG must purchase r - _'e the Budget Groups when dom.tstic supplies are short. For these reasoi... .t r'Aould be phased out gradually--perhaps over a three-year period and as r-Irt of a civil service pay reform package .5/ An alternative to eliminating the program entirely vould be to change the target group of BULOG distributions to '"w Income households as part of a poverty alleviation program. 5.27 Although BULOG does not have a monopcly of the domestic rice market, It retains a significant role in the storage and marketing of rice. To Increase the private vector's involvement and to reduce BULOG's budgetary costs, BULOG could gradually consolidate its operations by limiting its interventions to those areas of the country, where competition in the market needs to be ensured. This would eliminate the need for a number of sub- DOLOGs. All marketing functions would be performed by the private sector up to the point of intervention. Prices would be set for milled rice at the intervention point and would be differentiated by quality--moisture content, number of brokens, etc. In order to provide incentives for greater private storage, the intervention price could be increased during the first c3uple of months after the main harvest. The increase in prices would reflect the cost of storage. 5.28 In setting prices for its price stabilization program, Indonesia must continue to determine the relationship of those prices to world prices. World agricultural prices have trended downward in real terms over the past four decades. This decline is in part a consequence of technological change and need not lead to lower production or net farm incomes if farmers adopt cost saving technologies.58/ The tendency of many countries, however, is to prevent the decline from being passed onto domestic producers. Administered price systems, -ich like Indonesia's were originally Intended to Ai/ In 1985 and 1986, world prices were quite low and the rupiah Was overvalued. As a result, Indonesian prices were well above pari-v. Several commentators have, however, noted that domestic prices hi i followed world prices Jand have been kept constant in real terms. 57/ The elimination of Budget Group distributions would lead to some disruption of existing marketing channels. Therefore, a gradual phase- out is recomended. If/ Further study on these technologies and their possible impact on farm structure in Indonesia is needed. - 93 - stabilize domestic prices, then become a means to transfer income te certain elements of the farm pcpulation--in this case rice producers. Once these transfers become entrenched, they are difficult to remove. 5.29 Indonesia's policy should be to continue to keep prices at world parity. Raising prices above world parity would tax tho economy's labor- intensive manufacturing sector at an early stage in its development. Keeping prices below world parity would needlessly tax rice ;roducers. In order to formally link domestic prices to world prices, the ceiling price should be adjusted annually to reflect changes in vorld prices using a moving average formula of perhapu five years. The world price used in this formula would depend on Indonesia's net trade position. If Indonesia ctv;.inues to be self- sufficient in rice or tends towards net imports, the c.i.c. import price would be used. If Indonesia becomes a consistent net exporter of rice, the f.o.b. export price would be used. 5.30 Under the above price-setting process, the entire price band woild respond gradually to movements in world market prices. The intervention price would be based on the ceiling price after deducting a margin for storage and transportation costs from the intervention center to port. Since transportation ;osts from each intervention center will vary, a separate price structure could be set up for each center. However, this would lead to a complex price structure and it would be preferable to limit the number of intervention centers to a few areas near major ports.59/ Soybeans and Soybean Meal 5.31 Trade. Indonesia exported small quantities of soybeans in the early 1970s, but has been an importer of soybeans and soybean meal since 1974. Imports of both beans and meal have grown rapidly, paralleling the increase in human consumption and the demand for meal by the livestock feed industry. Imports of soybeans in the late 1970. ranged from 90,000 to 180,000 t and by 1986 had reached 360,000 t. Imports of meal were negligible in the 1970s, but had reached 310,000 t in 1986. The only break in the growth came in 1981 and 1982 when the government cut back imports in order to save foreign exchange. There are agronomic constraints on soybean yield expansion (para. 3.38). 5.32 In 1988, a new oilseed crushing plant was opened with a capacity of about 330,000 t of soybeans annually. By 1990, meal imports had declined to less than 20,000 t while soybean imports climbed to over 500,000 t in order to 59/ The inefficiencies in grain flows are inversely correlated with the number of intervention centers. One way to reduce these inefficiencies is through regional pricing. Another is to limit the number of centers to a few areas of the country. Harris et al (1983) note the following about regional pricing in the European Community: "an institutionally- determined set of intervention prices could never hope to reflect the conditions of any particular season when small climatic difference could significantly alter a region's net cereal balance. Consequently it gradually came to be accepted that the system of regionalization for intervention prices probably did more to distort than to smooth grain flows." - 94 - moet the needs of the crushing plant. In 1991, there was some recovery in meal imports because of the 1991 trade reforms (par.. 5.36). 5.33 Currently, about 50 percent of all imported beans are used by the crushing plant and 50 percent by the domestic food processing industry. The crushing plant uses only imported beans. The remainder is used by the tempe (soybean curd) producers because of their better quality and high extraction rate. Tahu (molded soybean cake, producers prefer domestic beans because of their high carbohydrate content and green color. 5.34 Policy Objectives. The objectives of soybean policy are to maintain stable prices, to provide soybeans to consumers at reasonable prices, and to provide adequate income to soybean producers. Principal policy instruments are: (a) soybean intensification programs, which provide subsidized fertilizer and credit; (b) the provision of high yielding seed through public seed corporation.l (c) extension services; and (d) trade restrictions which lead to high soybean and soymeal prices. In the case of soymeal, the government's policy has been to save foreign exchange by capturing the value- added irom domestic soybean processing. 5.35 Trade Regime. FULOG has the exclusive right to import soybeans and soybean meal. However, soybean meal was normally imported by both BULOG and by private traders under a special license issued by BULOG. Zhe cost of the license was 0.5 percent of the c.i.f. value plus any tariff and surcharges. In 1988, imports of soybean meal were banned in order to protect the new soybean p-ocessing plant. This ban was put into effect by refusing to grant new import licenses.60/ 5.36 Under the June 1991 package of trade reforms, soymeal import controls were lifted and soymeal imports were subject to a small duty of 5 percent. Some meal has been imported by privete traders under the new system and letters of credit have been approved for additional imports. However, the status of the deregulation is still uncertain. Apparently, there is pressure to continue the old system under which licensing approval by BULOG is requxred. In addition, a 35 percent surcharge has been added to the basic tariff of 5 percent. The surcharge is applied on soymeal imports of private traders but not on BULOG imports. It is due to be rescinded in 1992. 5.37 Price Reaime. Government trade restrictions on soybean Imports have led to consistently high soybean protection in Indonesia. As a result, domestic market prices have been well above the Government's floor prices for producers. Nominal rates of protection in the 19809 sometimes exceeded 100 percent, making soybeans one of the most protected commodities in the Indonesia food system. Imported beans are sold by BULOG at a Government- determined price to tempe and tahu cooperatives (ROPTIs) and to the Indonesian Soybean Association. 5.38 The price structure for soymeal was revised with the opening of the oilseed crushing plant. Formerly, soymeal was distributed at C0ot plus a 601 One of the large feed mills was able to obtain a license. This resulted in small soymeal shipments in 1989 and 1990. - 95 - small tariff by BULOG'. appointed importers. This resulted in a dualistic price structure in which soymeal prices were close to import parity while soybean prices were relatively hi8h. Such a price structure could function because Indonesia had no domestic crushing capacity. With the opening of the new soymeal plant in 1988, however, an administered price system similar to that for wheat flour was introduced (paras. 5.65-5.69). In effect, the crushing plant is paid a crushing fee and allowed to keep the soybean oil.4jj BULOG then takes possession of the soymeal and sells it at a government-determined price to the large feed mills and to ASBIMTI--an association which represents smaller mills. Recently, the BULOG price for meal was is high as 40 to 50 percent above the landed price of imported meal. This would be consistent with the tariff surcharge mentioned in para. 5.36. 5.39 The crushing plant receives about $11.50 for every ton of bean crushed. Assuming an oil extraction rate of 18 percent and a domestic oil price of $400 per ton, the crushing plant receives an additional US$72.0 in vegetable oil revenues, for a total of $83.50 for every ton of bean crushed. In comparison, the average spread between the price of soybeans and the value of meal and oil produced in the United States is about $20 per ton of bean crushed. The oilseed processing plant has created, perhaps, 350 jobs, mostly unskilled in packaging and handling. Assuming that the subsidy to the mill is US$63.50 ($83.50-$20.00) per ton and that the plant is operating at full capacity, the total subsidy to the mill is US$21 million annually or US$60,000 per job. 5.40 Policy Issues and Future Otions. Soybeans and soybean meal illustrate the dilemma that Indonesia will increasingly face as the economy becomes more diversified. In the case of food, higher incomes lead to more diversified diets and to greater degree of processing before foods are consumed (Section II). As a result, there are more substitution possibilities between food items in households diets and between raw agricultural inputs in agro-processing. Substitution possibilities are particularly strong in the feed milling industry. 5.41 Although soymeal is a preferred protein supplement in poultry rations and is the most important protein meal used in Indonesian rations, there are a wide variety of protein substitutes. These include meals of rapeseed, fish, meat and bone, peanuts, sunflower seeds, sesame seeds, corn gluten, and feather. None of these meals are currently produced in any quantity by Indonesia. However, they are readily available on world markets. Imports are subject to small tariffs of 5-10 percent and there are no licensing restrictions. As a result, these meals are relatively low priced in comparison to soymeal and imports have doubled over the past couple of years, rising from 150,000 in 1988 to 320,000 t in 1990. Feed ingredients, other than soybeans, are now Indonesia's third largest agricultural import. However, other protein meals are usually lacking in other nutritional characteristics. To ensure an economically efficient mix of feed ingredients, IL/ Soyoil competes with domestically produced vegetable oils. There apparently is little human consumption of soyoil and most is used for industrial processing or is exported. - 96 - therefore, the protection rate on soymeal should be decreased to 5-10 percent level. 5.42 Protection of feed ingredients would tax some of Indonesia's moct promising agro-prQcessing industries--including feed milling, intensive poultry production, and shrimp farming. Modern production technologies for these industries are readily available internationally and Indonesia has considerable potential to become a low cost exporter. It already exports shrimp. In the case of poultry, feed costs represent 60 to 70 percent of the variable cost of production and producers operate on thin margins. Relatively small changes in input or output prices give rise to large swings in output. 5.43 High cost feeds would also tax other livestock industries with considerable potential: pork, dairy and beef. Although Indonesia is a deficit producer of protein meals, it produces abundant high-fiber energy feeds. These feeds are used intensively in the production of ruminants and can also be used in pork production. Three such feeds, copra meal, cassava pellets and palm kernel meal, are currently exported to the European Community because of their high fiber content and the limited demand within Indonesia.62/ According to the projections in this report, Indonesia could also have abundant supplies of corn for intensive pork production, beef finishing rations and lactating dairy cows. The export potential of the livestock industry needs further study (para. 7.23). For example, a number of countries in Asia are cutting back pork production for environmental reasons. Indonesia, with its greater abundance of land resources Off-Java, could potentially move into these markets. 5.44 High soybean prices also tax one of Indonesia's largest existing agro-processing sectors. There are thousands of small-scale, labor-intensive tempe and tahu producers located in rural areas on Java. This sector is a major contributor to rural employment and incomes. High soybean prices may limit the growth of these industries Off-Java and the industry's diversification into a wider range of soybean-based products--soymilk for example. Soybean-based products are an important source of protein in human consumption and lower prices would increase protein consumption by the poor. 5.45 There are also reports of excessive distribution costs and rent- seeking behavior under the current marketing channel for imported beans. Not only are distribution costs higher than for domestically produced beans, but BULOG allocations to KOPTIs are generally inadequate to meet the needs of tempe producers. Producers are forced to purchase supplies from area wholesalers who purchase their beans from the Indonesian Soybean Association. 5.46 Because of the strong links between soybeans, meal and other commodities in finaL demand and downstream processing industries, a major aim of government policy should be to deregulate this sector. Licensing restrictions on soybean imports should be eliminated and replaced with a tariff identical to that for soymeal. Soymeal imports should remain deregulated and opened to the private sector under the same tariff structure 62/ Copra meal and palm kernel meal are used in EC cattle rations. Annual Indonesian exports are about 450,000 t and 300,000 t, respectively. - 97 - as that faeed by BULOG. The tariff on soymeal should be as low as possible in order to encourage the development of the feed milling and livestock industries. At the same time, the fee structure for the crushing mill should be eliminated and the industry opened for p-ivate investment and increased competition. Sugar 5.47 Trade. Indonesia was once one of the world's largest exporters of sugar. In the 1920s and 1930s, exports ranged from one to two million tons, but the industry went into decline and the mills fell into disrepair following the depression and World War II. Since 1967, Indonesia has been a sugar importer although it retains its status as an exporter under the International Sugar Agreement. 5.48 Imports average about 100,000 t per annum in the early 1970. but then climbed rapidly in the latter part of the decade, reaching almost 800,000 t in 1981. The increase was due to rising demand and slow growth in production. The latter is due to a decline in the sucrose extraction rate, from 11 percent in 1976 to under 8 percent in 1983. Sugar imports were negligible in the mid-1980s because of flat demand and the high stocks that had been built up earlier in the decade. After the 1987 drought, imports climbed again and are currently running about 300,000 t per annum. 5.49 Indonesia's annual production of molasses, a by-product of the refining industry, is approximately 1 million t. Approximately 50 percent of all molasses production is exported. Principal export markets are the EC, Japan, South Korea and Taiwan. The remainder is used in the domestic alcohol industry and to produce monosodium glutamate. A very small, amount is used by the domestic feed industry. 5.50 Policy Oblectives. The objectives of Indonesian sugar policy are to, maintain price stability, to provide sugar to consumers at reasonable prices, and to guarantee the incomes of sugar cane growers and sugar plants. Principal policy instruments are a smallholder intensifi':ation program (TRI), the development of new estate plantations on the Outer Islands, the rehabilitation and expansion of mill capacity, and an administered price system which leads to high sugar price supports. Under the TRI system, farmers receive subsidized inputs but are forced to cultivate cane periodically in order to ensure an adequate supply to the mills. Prior to the implementation of TRI, farmers were forced to lease their land to the mills. 5.51 Trade and Price Regime. Although BULOG has the exclusive right to import sugar, actual purchases are made by agents appointed by BULOG. These agents are reportedly paid commissions of US$15 per t, compared with commissions of $0.50 to $1.00 per t in other countries. Molasses exports are controlled by a single state-owned marketing board. 5.52 Sugar is one of Indonesia's most regulated commodities. The Government sets the price to producers, the mill buying price, and the ex- factory price for sugar. BULOG is the sole purchaser of nearly all domestically produced sugar and also exercises considerable control over the - 98 - domestic distribution of sugar. Only licensed distributors are permitted to obtain supplies from BULOG's regional warehouses.03/ 5.53 Since BULOG sells sugar at a price which is generally above world prices, food processors who use sugar in the production of exported food products should be able to avail themselves of the BAPEKSTA duty drawback scheme. However, sugar is normally traded in minimum orders of 12,000 tons which is considerably above the annual consumption of the largest processor. Although large processors are able to negotiate a discount on their sugar purchases from BULOG, most must pay the inflated wholesale price and do not receive a duty drawback. 5.54 The administered price structure for sugar, including the farmgate or "Provenue" price, is determined by consultations between various government agencies. The farmgate or provenue price is set at 2.4 times the price of rice. Farmers must deliver their entire output to the mills. Two percent of that output is returned, after milling, for their own domestic use. A-Cw.al payments for the remaining 98 percent are determined by a revenue-sharing formula with the mills. The formula varies with the estimated sugar extraction rate. For an average extraction rate of 8 percent, the farmer receives 62 percent of the farmgate, or "Provenue" price, and the mill receives 38 percent.64/ Although the revenue-sharing formula is determined by administrative fiat, the result is similar to that determined by market forces in cane growing regions of the United States (60-40 in the State of Louisiana). Table 5.4: ADMINISTERED PRICE STRUCTURE FOR SUGAR (April 1990) US Dollar per t Farmgate or Provenue Price 351 Excise and sales taxes 51 Insurance and bank fees 24 Bag cost 9 Miscellaneous 4 Ex-factory price 438 Wholesale price (Jakarta) 537 * Exchange rates Rp 1,832.8 - US$1.00. 631 Under recent reforms, producers in the Outer Islands are allowed to market from 50 to 75 percent of their output on their own account. 64/ Farmers also receive a payment on 1.86 kilograms of molasses for every 100 kilograms of cane delivered to the mills. - 99 - 5.55 Estimates of nominal protection for the Indonesian sugar industry have ranged 30 to 100 percent over most of the last twenty years and indicate that the industry has been highly protected. However, recent estimates may overestimate the degree of protection. Table 5.4 provides the administered price structure for sugar as of April 1990. Assuming an import price of about $400 per t including transportation and handling costs to the Jakarta wholesale market, the nominal protection rate in 1990 would be 34 percent.65/ This is the tax on sugar users. However, the wholesale markup also includes US$51 in taxes which should be subtracted from the wholesale price to make it comparable to the import price. This gives a nominal protection rate of 21.5 percent. 5.56 Policy Issues and Future ODtions. Studies on the profitability of sugar production on Java indicate that both the financial and economic returns to sugar production on irrigated lowlands are negative.66/ In spite of the high protect40n afforded the industry, therefore, farmers on irrigated lowlands are actually taxed by the current system. Clearly, the government's policy to mandate sugar production on irrigated wetlands on Java is economically inefficient. Whether sugar production should be promoted on Javanese uplands and Off-Java requires more analysis (para. 4.42). 5.57 In the early 1980., Indonesia embarked on an ambitious program to rehabilitate existing mills and significantly expand its milling capacity. Plans were drawn up to construct 18 new sugar mills. Because of revenue constraints and the lack of private interest in the financing of these mills, construction plans were scaled back to seven. Currently, there are 67 sugar mills, 57 on Java and 10 Off-Java. Sixty of the mills are government owned. 5.58 Deregulation should initially focus on state ownership of the milling industry and the BULOG's control over the distribution of refined sugar i.e., opening of the industry to private investment and increased competition. Sugar might be a good test case for moving to an open tender system. BULOG already appoints private sector agents to handle sugar imports and an open tender system would eliminate the high commissions which are apparently paid to these agents. 5.59 Indonesian prices have consistently been much higher than world prices in order to protect the industry. An often used justification for this is that sugar is one of the most protected products world-wide and world prices are low because of developed country subsidies. However, economy-wide welfare would still be improved if Indonesia took advantage of low-cost sugar imports. Many of the problems in the industry arise between the time sugar is harvested and delivered to the mills for processing. These problems have not been solvod by high prices or by government attempts to regulate the problems away. 65/ The nominal protection rate is usually calculated by comparing the Jakarta wholesale price with a landed import price (537 + 400 - 1.34) 66/ Seep for example, Gerald Nelson and Martin Panggabean, "Indonesian Sugar Policy," American Journal of Aericultural Economics, Vol. 73, No. 3, August 1991. - 100 - 5.60 Pricing decisions for sugar must also take into account other policy objectives.67/ High prices introduce several taxes: (a) on the production of rice and other crops which compete with sugar; (b) on the consumer for which sugar is a basic food commodity; and (c) on the food processing industry for which sugar is a major input. The latter is especially important given the Government's policy to expand non-oil exports. Low-cost sugar is essential to the export of many processed food products for which Indonesia potentially has a comparative advantage. Over the longer term, therefore, sugar prices should be reduced to import parity. This may not require a major realignment in sugar prices since according to the World Bank's projections for primary commodity prices, the world sugar price (nominal US dollars) will increase by about 5 percent per annum between 1990 and 2005. With the exception of tropical vegetable oils and beverages, this is the highest rate of increase of all primary food commodities. Wheat and Wheat Flour 5.61 Trade. Indonesian wheat imports have grown rapidly, from 500,000 t (wheat grain equivalent) in 1972 to 1.9 million t in 1988 and wheat has replaced rice as Indonesia's most important food import. In 1991, imports surged to 2.2 million t, as a result of the poor rice harvest. Imports have been used to fill Indonesia's import food gap and to help control inflationary pressures. In 1971 and 1972, three flour mills were opened in Jakarta, Surabaya and South Sulawesi. Since the opening of the mills, imports have been almost entirely in the form of wheat grain. Flour is imported only to meet short-term shortages. Although Indonesia still imports wheat on concessional terms, most imports are non-commercial. 5.62 Nearly all wheat is destined for human consumption. Flour consumption is about 6.5 kg per person per year and provides about 2.5 percent of all calories consumed. Wheat is consumed primarily by high income households in the form of noodles, bread, and a variety of other processed products. About 130,000 t of feed quality wheat is imported for industrial glue in the plywood industry. 5.63 Policy Objectives. Since wheat is not produced in Indonesia, government policies are oriented towards the consumer. The principal goal is food price stability. However, the role of wheat, and consequently the policies towards it, have changed over time. In the 1970., controlling inflation was a primary concern and substantial food imports were necessary. The principal issue was the trade-off between rice and wheat imports. Indonesia was the world's largest rice importer in a thin world market and substantial rice purchases would drive up world prices. Wheat, on the other hand, was more widely traded internationally and was a cheaper calorie source. The policy, therefore, was to substitute imported wheat for rice by keeping flour prices relatively low. In the 1970s, rice prices rose on average by 17.5 percent per annum, compared with 13.5 percent per annum for the price of wheat flour (Annex III, Table 3.3, Volume II). 67/ Although sugar prices are relatively high, their rate of increase has been the lowest among the major food commodities during the past two decades (Annex III, Table 3.3, Volume II). - 101 - 5.64 In the 1980., Indonesia achieved a reasonable degree of price stability and became self-sufficient in rice. The policy emphasis apparently then turned to the trade balance. Although wheat imports have continued to grow, the Increase ha not been fast enough to prevent flour prices from rising more rapidly than rice prices. The Jakarta wholesale price for flour rose by 12.8 percent per annum during the 1970s, compared with 11.3 percent per annum for the price of rice. 5.65 Trade and Price Regime. BULOG has had monopoly control over wheat and wheat flour imports since 1972 when control was transferred from the Department of Trade. However, wheat purchases are actually arranged by the flour mills. The mills are owned and/or managed by a single company. 5.66 The domestic flour market is highly regulated through an administered price system. BULOG sets the purchase price of wheat to mills and the ex-factory price of flour to distributors (Table 5.5). It also determines the allocation of wheat to each mill and the allocation of flour to various parts of the country. All flour distributors must be licensed by BULOG. Distributors consist of private traders, who are members of the Association of Sugar and Flour Distributors, and cooperatives, such as the Jakarta Bread Entrepreneurs Cooperative and Village Cooperative Centers. Although BULOG also sets a standard retail price in regional markets, it cannot control retail prices directly. Rather, it uses regional allocations of flour to influence prices. 5.67 The listed price at which the mills receive wheat from BULOG is usually well below the landed price of imported wheat, particularly wheat purchased on commercial terms. The loss is absorbed by the Department of Finance. During the 1970., this also resulted in a subsidy to flour consumers which averaged about $60 per t. In 1980, however, the government introduced a "surcharge" to offset the subsidized price of wheat. The surcharge is paid by distributors and ls returned to the Department of Finance. When it is greater than the subsidy on wheat, the system results in a tax on consumers which is paid into general revenues. 5.68 In November 1988, the mill purchase price for wheat was $86.27 per t (Table 5.5). A rough estimte of the import price of wheat is $146 per t (based on the import unit value for 1988 and a small handling fee). The Implied subsidy, therefore, was $59.73 per t, or $80.72 per t on a flour equivalent basis."/ Sines the surcharge was $95.49, the tax on flour consumers was $14.77 per t. There is also an implicit tax via the mill margin. 5.69 The administered price structure also covers mill processing costs and profits. In 1988, the mill margin was $35.70 per ton, or 31 percent of the flour equivalent price of wheat.69/ In contrast, margins in the United States are about $10 per t, or 6 percent of the flour equivalent cost of 68/ $59.73 divided by a milling rate of 0.74. This is the subsidy on the wheat required to produce 1 t of flour. "Iu The margin was only 24 percent in 1980. - 102 - Table 5.5: ADMINISTERED PRICE SYSTEM FOR WHEAT AND WHEAT FLOUR (November 1988) US Dollar per t la Landed price of wheat 146.00 Mill purchase price for wheat 86.27 Flocr equivalent price 116.59 (Basea on milling rate of 0.74) Mill margin 35.70 Other 0.40 Subtotal 152.69 Surcharge 95.49 BULOG fee 10.53 VAT and other taxes 31.14 Ex-factory price for flour 289.85 Average wholesale price 369.46 la Exchange rate: Rp 1,709.6 - US$1.00. wheat. This extra cost is paid by flour consumers. In addition, the mills receive a subsidy from the sale of milling by-products. In 1988, milling by- products generated extra revenues of about $38 per ton in both Indonesia and the United States. However, the input cost of wheat was subsidized in Indonesia. 5.70 Policy Issues and Future O2tions. Two policy issues arise in the context of the marketing system: (a) are the current set of policy objectives correct? (b) are there minor reforms which would improve the efficiency of the wheat marketing system or are more substantial reforms required? 5.71 Indonesian policy should be to keep flour prices at world market parity. This is the case whether Indonesia is a net importer or exporter of rice. If rice deficits develop, Indonesia would be better off importing wheat as a cheaper calorie source since world rice prices are generally much highr than wheat prices. If rice surpluses develop, Indonesia would be better off exporting rice at its higher price and gaining the value-added from processing wheat at home, since wheat flour requires greater procesing than milled rice. 5.72 The regulatory environment for wheat and wheat flour potentially leads to rent-seeking activities and inefficiencies throughout the marketing chain. For e*maple, there is apparently no competition in flour distribution channels since distributorshilps have been fixed since the early 1970s. Also, there are only three types of flour produced in Indonesia; and flour quality - 103 - and price. are determined by Goverment decree. A. a result, the needs of the Indonesian baking industry are not reflected In the market. The industry must adjust its production practices to the flour sold by mills whereas it would probably be moro efficient for the milling Industry to produce a greater variety of flours and thereby adjust to the needs of the baking industry. The current administered price structure appears to be a hold-over from the days when wheat and wheat flour were imported on a concessional basis. There is no apparent reason for subsidizing wheat to the mills while imposing a surcharge on consumers. By raising the price of wheat to the mills, the government could eliminate both the surcharge and the mill subsidy on the production of milling by-products. Apart from this, minor changes in the regulatory environment might well lead to Improved mill profits rather than greater economic efficiency. This is because a critical component of the marketing system is the monopoly on flour milling. A. a result, more substantive deregulation is necessary. 5.73 Major deregulation options that 001 may consider in the future ares (a) Elimination of licensing controls over flour imports. (b) Elimination of the administered price sy 'n, Investment restrictions on flour milling, and all licensing requirements in the distribution chain. (c) Above, plus elimination of BVLOG' control over wheat imports and replacement with tariff, if necessary. Other Commodities 5.74 Cassava (SC luotas). Indonesian cassava exports were fairly stable and averaged about 300,000 t during the 1970s and early 1980.. Since 1984, however, exports have risen dramatically, reaching 1 million t in 1988. The primary export markets for cassava are the northern countries of the European Community (EC). These markets are essentially a creation of the EC's Common Agricultural Policy (CAP). Undar the CAP, SC grain prices are held well above world prices while nongrain feeds can be imported at low or zero duties. As a raoult, cassava mixed with a high protein feod such as soymeal is more attractively priced than domestically produced EC grains.70/ Most of the cassava is probably fed to pigs. Although cassava can be fed to other animalo, it is least constrained In pork rations which can contain up to 40 percent cassava. 5.75 The European Community views nongrain feed imports as a loophole in its Common Agricultural Policy. It gains little revenue from nongrain feed Imports. At the same time, those imports substitute for EC-produced feed grains which are then exported at considerable cost to the EC budget. As a result, the Community has attempted to restrain imports of nongrain feeds and 201 In the mid-1980s, the price of corn In the EC was roughly 60 percent above a comparable mix of 80 percent cassava and 20 percent soymeal. In Indonesia and Thailand, or the other hand, the price ratio was closer to one-to-one* - 104 - has signed quota agreement. for cassava with Indonesia, Thailand, and other minor suppliers.71/ These quotas have been very effective at restraining EC imports, which stabilized at about 6 million t during the 19808. 5.76 The annual quota for Thailand has been about 5 million t and has been binding throughout the 1980.. Indonesia's quota is 825,000 t through 1992 and only became binding in 1988. At that time, Indonesia introduced a quota allocation scheme. A part of the quota is allocated to small firms while the remainder is based on an exporter's performance in non-EC markets. 5.77 Under the quota arrangements, the exporting country must arrange to limit exports. Rents, therefore, accrue to exporting countries. In 1989, for example, the SC price for cassava pellets was about US$152 per ton. The wholesale price for dried cassava in Lampung was about US$57 per ton. Assuming a slightly higher wholesale price of US$61 per ton for cassava pellets, that the Indonesia fob price is the same as the wholeasle price, and that transportation costs to the EC are US$42 per ton, quota rents may have reached US$40 million in 1989.221 5.78 The method of allocating quotas in Indonesia results in a loss of revenues to the Government. A portion of the quota rent accrues to cassava exporters in Indonesia. The remainder accrues to importers in non-IC markets. The exact distribution depends on the extent to which cassava must be discounted in non-EC markets. The discount could be quite large since those markets are very thin. In 1988, for example, Indonesia's non-EC exports were only 20,000 . The Indonesian government could eliminate the implied subsidy to non-IC markets and garner part of the quota rents by auctioning the quotas. 5.79 Reaional restrictions on trade may also have a significant impact on Indonesia's trade performance and on regional development. Such restrictions raise the cost of Indonesia's exports both directly and indirectly by preventing the development of an integrated national market. A national market is necessary to garner returns to scale in marketing and processing. This is already made difficult by distances and high transportation costs between Indonesia's large number of islands. Internal trade restrictions also prevent the development of regional production patterns based on comparative advantage. This is important to the development of the Outer Islands which often lack the resource base for a diversified economy. 5.80 It is difficult to gauge the importance of internal trade restrictions in Indonesia, but numerous examples have been reported. They include regulations, fees and taxes on production and on intra- and inter- regional trade. There are also restrictions and fees at port facilities. Some of these fees represent payment for services rendered and are an important source of provincial and local revenues. Others give rise to inefficiencies. 71/ The Community has been unsuccessful at obtaining a similar agreement with the United States on corn gluten feed. 72/ US$40 million - (US$152 - US$61 - US$42) x 825,000. Indonesian cassava prices were much higher in the two years before 1989. Thus, the rents generated by the cassava quota would have been lower In those years. - 105 - For example, the Directorate General of Fooderops (1988) 73/ found that movement permits and passage fees raised transportation costs by nearly 100 percent between Soppeng and Ujung Pandang in South Sulawesi. High passage fees were also found in Lampung Province of Sumatra. Their importance, as well as ways to rationalize the system, needs further study (para. 7.23). Box 5.1: INDONESIAN POLICIES AND THE AGRICULTURAL NEGOTIATIONS OF THE URUGUAY ROUND J/ A successful Urug-ay Round would bring agricultural policies worldwide under GATT rules and discipl!es and reduce the role of governmenut in detenmnintg agricultural trade. The Round Is particularly important to a country like Indonesia vith considerable agricultural potential. Although the RounD has been in progress for over five years, there are a host of unresolved issues. Nevertheless, a final agreement is likely. That agreement would likely place disciplines on agricultural policies in three areas: Import access, export competition, and internal support. Under special and differential treatment, developing countries such as Indonesia would be allowed more flexibility In implementing refoums. Smaller reductions In support would be required, a longer Implementation period would be permitted, and some agricultural policies would be exempt from GATT discipline. Imuort Access * In 1993, tariffs would be placed on all products subject to state licensing controls or other non-tariff import barriers. In Indonasia, this would include rice, soybeans, sugar, wheat and wheat flour, and processed foodsi. Tariffication would eliminate the monopol'.es of BULOG and state trading corpor'Ations over imports of these products. * By 1993 and for each of the above products, Indonesia would also have to guarantee 3 percent of Its domestic markat at zero or low duty. In the case of rice, for example, this vould imply that private traders could import up to 750,000 t at little or no duty. - Indonesia's use of tariff surcharges vould be subject to GATT disciplines. Tariff surcharges could only be applied under conditions spelled out in a special safeguard clause and would be limited in duration to the year In which they are Imposed. ! * Tariffs would be reduced by 24 percent over a ten-year period beginning in 1993. Guaranteed market access vould increase from 3 to 5 percent of domestic consumption over tha same tlme period. Export ComnetitIon * Export subsidies would be subject to commitments on budgetary outlays and the quantity receiving subsidies. Indonesia's programs for export credits, export credlt insurance and pre-shipment export finance vould be classified as export subsidies. However, Internationally, disciplines for credit and credit guarantee programs have not been agreed to. As a result, changes in Indonesia's export programs may not be required. Continued - I/ Based on the GATT Secretariat's draft text for the Agricultural Negotiations of the Uruguay Round (December 12, 1991). 73/ Directorate General of Foodcrops, Sup2lY and Demand for Foodcrotso in Indonesia, Ministry of Agriculture, Jakarta, Indonesia (January 1988). - 106 - Internal Sunuort * Domestic Food SubAIdipe--Domtic food subsidies would be permitted provided that they are based on nutritional neaed. Since Indonesia's rice distribution program for civil servants and the a*md forces Is not based on nutritional criteria, It would be subject to G"IT disciplines. * Public Stockholdlnn for Food Security--Public stockholding would be permitted provided that It does not provide price support to producers. Since BULOG'os interseasonal price stabillzation program supports prices during peak harvest months, It would be subject to GATT disciplines. * Input Subsidies--Developing countries would be allowed greater flexibility In the use of Input subsidies. For example, subsidies which are generally available only to low-income or resource-poor producers, would be permitted. If Indonesia's fertiliser and credit subsidies meet this criteria, they would not be subject to GATT disciplines. Tble Is the case even though these subsidies may not be justified from resource allocation, efficiency and environmental viewpoints. * Administered Pricee--Price support arislig from administered price systems for rice,s ugar and other BULOG controlled products would be Included under Internal support. This is the case even though these commodities are also subject to tarrifIcation. Where tariffs are set low enough to allow private trade, administered prices would no longer be effective. Where tariffs are set so high that BULOG continues to monopolize Imports, administered prices would be subject to GATT dliciplInes. - * Internal support programs subject to GATT disciplines would be reduced by 13.4 percent over a ten-year period beginning in 1993. Internal support would be measured by an Aggregate Measure of Support or AMS. In general, the Aggregate Measure of Support Is calculated on a product-specific basis and includes all goverament subsidies for a coumodity plus a measure of the market price support received by that comsodity. Market price support is generally calculated as the gap between a fixed external reference price and the administered price multiplied by the quantity of production eligible to receive the adminlstered price. * Although the required reductions in administered prices for sugar and soybeans are relatively small, these reductions are set In nominal terms and would involve much larger reductions in real terms. * A de minimis standard of 10 percent would apply to developing countries. If the Aggregate Measure of Support for a particular product is below 10 percent of the value of production, no reductions would be required. With the exception of sugar and soybeans, this standard would probably be met for most commodities In Indonesia. As a result, uo chau.es in internal support would be required for commodities other than sugar, and soybeans. For example, if the Aggregate Measure of Support for rice is below 10 percent of the value of rice production, no changes in fertilizer subsidies, domestic rice subsidies, or adndnistered rice prices would be required even though these policies may not meet the criteria for the permitted programs. - 107 _ VI. IMPLICATIONS EOR FUTURE DEVELOPMENT OF TI SECTOR AND THE ECONOMY 6.1 Ovnorvle. This section presents projections for agricultural GDP through the year 2010. At 3 peroent per annum growth rate, the sector will provide a continuing basis for reduction of poverty. A strategy of rice self- sufficiency may not, however, be congruent with a policy for alleviating poverty, as in the past. In Java, the poverty is increasingly becoming an urban problem sad, farmers off-Java, may not always have an adequate resource base. This does not, however, reduce the importance of a concurrent reduction in rural poverty, which is needed to prevent the urban poverty from getting worse. It li of crucial importance that non-agricultural activities should be permitted to evolve, use of lanu should not be regulated and the growh,u of processing should not be inhiLlted by licensing and pricing policies. The structural transformation process, both in the post and future, is examined. Agriculture will continue to contract as a proportion of the total output %s well as total employment, although the latter will tend to lag. The report contends that attempts to slow the rate of movement of labor out of agriculture through price interventions (protecting agriculture) will be largely ineffective. The policy emphasis should be on enhancing productivity of labor throughout the economy and not on finding ways for agriculture to absorb surplus labor. Expansion of employment opportunities outside agriculture does not necessarily imply migration from rural to urban areas. Growth in Aericultural GDP 6.2 In order to estimate whether the past momentum of agricultural growth is likely to be regained or to decline, this report presents a likely scenario for agricultural GDP through 2010. These projections are presented in detail in Table 6.1, and summarized in Table 6.2. The GDP projections are based on the comodity projections presented in Chapter III. For two products, rice and corn, different growth rates are assumed, For rices the supply projections in Chapter III represent ,otential growth, and involve the emergence of a safety margin over domestic demand. For reasons given in paras. 3.30, it is unlikely that the potential future growth of rice output in excesw of domestic demand could be translated into exports. Thus, actual trend growth of future rice production is projected to be the same as the growth of domestic demand. The rates of growth of supply and of the GDP contribution for any product can differ if there are economies or diseconomies Tabla 6.J, ISOM Olt A00U*MIAL GM (MA-OMMl). 1966-2010 Obar. Shag~a O.. v3. ~ C.r Sae fO. It. Value Shr hr r. Itt.GM vlea *A It"6 mubt. totat "in9. 32M subtotal total 60,6 NO zo s abt. total 651200 200 .ubt. total 2000.05 2OO aubt. tota 05-10 2010 subt. total Rue. 10.344 0.45 2.0 10,76 0.45 2.0 13.682 0.65 3.6 12.063 0."5 1.4 11.769 0.45 1.2 14.47 0."4 Cog. 1.514 0.10 1.7 1.414 0.16 3.7 3,652 0.11 4.5 2.430 0.12 5.0 2.ll" 0.15 5.0 5.220 6.16 3oot crop. 2,443 0.36s 0.0 2.443 0.15 0.0 2.441 0.14 .0.4 2.432 0.5.2 -0.7 2.329 0.33 .0.9 2.224 0.30 Sqlbe 1,551 0.30 2.6 1,643 0.10 2.6 3.664 0.10 2.5 2. 1)2 0.10 2.5 2.412 0.31 2.3 2.126 0.1 subtoutalsi.r j3!0 to.")6 1.-# 36.2 3.00 fl32 a.. 16.390 A0 O." 3 la s,.81 a... 0.43 - 21.324 j.%00 0.18 3N a3!~ Veetable. 2.245 6.56 .J 3,449 0.56 3.3 4.016 0.54 331 4,681 0.54 .1. 5.45. 0.51 2.1 4.15 0.4" limit 2.33 0.41 4.6 2,496 0.42 4.6 2.84 D.44 5.3 4,044 0.44 3.4 5,811 O."6 5.6 1.98 0.52 StsaseL A0 am1: £IAm La hE 1la hAL L RID ):! ILa 3d LaM bE Lda la lima L&3 MO Li am33 La la Sq., m 368~1.4 6.6 6.0 943 3.49 0.63 3.0 Im04 3.06 0.63 2.0 I'm5 1.68 0.62 2.0 ~ -2P 1.66 0.63 8.0 3,40 3.6 0.63 IIIIS soon 0.36 4.4 3g3ne 6.32 4.4 6,655 @41 S.1 3,46 0.53 5.5 4,45 0.31 5.0 SJSO 0.38 Milk 66 0.63 6.0 66 0.01 0.0 66 0.01 6.0 66 0.01 6.0 Of 0.01 0.0 o6 6.63 1e ,31 0.18 4.2 13.54 0.20 4.2 1is6 0.22 5.1 2,448 0.32 5.2 sow3 0.2 4.0 5.66 0.2n Fih 2.005 0.44 5.2 3,104 0.44 5.3 4.06 0.44 5.2 5,34 0.44 5.0 4,576 0.46 5.0 0.30 0.44 Subtoal b!M id0 Wool6 La isml 3.00 0.36 La LEE0 1:3! OLU La 33.303 j.3! 0j .5.2 34,276 -0 3d! 3d2 36.1)6 9:4! OhE Cocoit Is 1.40) 0.20 3.3 .3501 0.20 3M I'm4 0.36 3.2 2.0l 0.20 3.2 2.413 0.21 3.2 2.044 0.322 til Pam At 402 0.13. 710 014 .5 1.057 017 3.2 3,1176 0.11 2.0 1.301 0.14 2.0 1.437 0.14 ft% Les 3 71 0.00 ".5 36 0.0O3. 472 ::06 3.3 5 24 0.07 .3.4 463 0.06 0.0 4"3 0l05 3awevagaao 1.545 0.34 3.0 3,456 0.33 2.0 1.62 0.s2 5.0 2.126 0.52 2.6 2.556 0.12 2.6 2,637 -.23 C "so1404 700 '5.35 3.6 740 0.35 2.6 646 0.14 2.8 915 0.14 2.6 1,116 0.14 2.8 1.26 0.14 Subetota -4.44 5.00 t0.346) 3.6 - 1:3! 0.34 5.9 W.06 1.00 0.35 2.0 .6819 1.00 0.35 2.5 7694- I an 0.14 1:1 6.666 I.30 0.14 Total 32.663 J. 3.i 35.044 3.00 2 .21 41.038 1:3! 1.0 47.780 1.0-0 3.0- 23.31 1-00 1-1 15.02 1.00 for.otuy 322,63 0.64 3.1 25,028 0.94 3.1 40,681 0.65 3.0 41.494 0.65 3.1 53.20 0."4 3.2 "."I4 0.96 FroreataT 2.41 0.06 3.0 2.102 0.04 1.0 3210l 0.05 1.6 2,322 0.05 1.0 2.441 0.04 1.0 3al45 0.04 Tat" j3,33j id0!IO f0 l0 3f0l 1:3! L1 33djj 1-3! 130 76 9Z.33j bEb 9711 Id! IjCocomote Calculated fgos TbOU 31.1 Y.. Cro Sapot. 1665.2000 gpenb rtne easid to perslst until 2010. Oi" Palm Dommetia pestS. 3m dom6e pojojeoti. mP"ort f ro PCIm. ProJctic.. pp. 230. SbaaCalcolated 3cm Tre Crop Uqpst. pp. 46. ezc*pt that 1995-2000 growth rate vae extrrpolatad to 2000-2010, uhig put. it sore In Iln ulIb Prim Proeatima. pp. 266. 3woraewa Frm MrI. Projetiorn, pp3. Coffeeo trn Spceslamie bUinate.. - 109 _ in the use of off-farm cash 'nputs, such as fuel, fertilizer and pesticides.74/ For rice and, to a lesser extent, corn, savings in costs are expected from more efficient fertilizer use, the introduction of new varieties, and the judicious use of pesticides in the context of an integrated peat management. The elasticities of input use relative to that of output are assumed to be 0.8 and 0.9 for the two products, respectively. 6.3 The projections of agricultuk.al GDP (Table 6.2), suggest that growth from 1990 onward will stabilize at around 3.A percent per annum, about the level achieved for the 1985-1990 period. Th,.s is significantly higher than the estimate from the BAPPENAS model, which projects agricultural GDP growth Table 6.2: GROWTH RATES OF AGRICULTURAL GDP (percent per annum) Actual /a Prolected /b 1975 1980 1985 1990 1995 2000 2050 -80 -85 -90 -95 -00 -05 -10 Farm food crops 4.4 4.4 2.5 2.4 2.3 2.2 2.3 Non-food crops 6.5 5.4 3.8 3.9 2.9 2.5 2.6 Livestock 0.9 5.8 4.1 5.1 5.2 5.1 5.2 Fisheries 6.6 3.7 4.9 5.2 5.2 5.0 5.0 Total 4.5 4.7 3.1 3.1 3.0 2.9 3.0 Forestry 3.8 -12.1 5.9 1.0 1.0 1.0 1.0 /a BPS and World Bank Economic Report 9498-IND, p. 15. Lb Mission Eotimates. 74/ The formula connecting the two growth rates is r, - ry (1 - kf), (1 - f) where r, and r, are the rates of growth of value-added and of the gross value of output (equal to that of production under a constant-price assumption); f is the proportion of gross revenue subtracted to calculate value-added; and k is the ratio of the rates of growth of cash costs to that of output. If k >1 (k <1), costs grow at a faster (slower) rate than output, reflecting inefficiencies (efficiencies) in resource use. The differences between supply and value-added growth rates are not usually large. For example, if r, - 0.040, k - 0.75 (reflecting significant improvements in efficiency of resource-use), and f - 0.1 (a likely value for food crop products), r, - 0.041, or within 3 percent of r,. - 110 - of 2.5 percent per annum from 1991 to 2000 (para. 3.64). Growth rate estimates from the two approaches are summarized in Annex I, Table 1.5, Volume II. 6.4 Within agriculture, the growth of farm food crops is expected to be about 2.3 percent per annum over the 1990-2010 period. The growth of non-food crops is expected to decline from 4.0 to 2.5 percent per annum, and livestock and fisheries are expected to grow by over 5.0 percent per annum over the entire twenty year period. The effect of these differential growth rates is a more diversified composition of value-added in agriculture. The share of food crops (Table 6.3) is projected to decline from 68 percent in 1988 to 60 percent in 2010, with non-food crops holding steady at about a 14 percent share, while the share of livestock and fishery products increases about 50 percent each (10 to 15 percent and 8 to 12 percent, respectively). Table 6.3: SHARE OF AGRICULTURAL GDP (percent) 1988 1990 1995 2000 2005 2010 Farm food crops 68 67 66 64 62 60 Non-food crops 14 15 15 15 14 14 Livestock iO 10 11 12 13 15 Fisheries 8 9 9 10 11 12 Total 100 100 100 100 100 100 6.5 Diversification out of products experiencing slow growth of demand (or constraints upon supply) is expected, provided that market forces are allowed to operate. In addition, diversification out of land-intensive products-food and non-food crops-and into products which require ltttle or no land-horticulture, livestock, aquaculture, marine fisheries is expected. The share of agricultural GDP contributed by the land-intensive food crops (rice, corn, soybeans and root crops) is projected to decline from 48 percent in 1988 to 35 percent in 2010; the share of land-saving crops (fruit and vegetables) is expected to increase from 17 percent to 21 percent, while livestock products are likely to increase from 18 percent to 28 percent (Table 6.1). These movements economize on the use of one of Indonesia's scarce resources- irrigated land on Java. 6.6 It should be further noted that the 3 percent per annum growth rate of agricultural GDP is still high relative to total population growth, rural population growth, and growth in most other countries. Together with growth in non-agricultural activities in rural areas, it provides a continuing basis for reduction of poverty. - 111 - Impact on Poverty Alleviation 6.7 Indonesia's success in reducing poverty is now well known.75/ The policy of rice self-sufficiency was not only economically efficient, but also turned out to be a policy for alleviating poverty, mainly because producing rice was the main activity and source of income for the rural poor. The Iftidence of rural poverty declined from over 40 percent in rural areas i4 1976 to just over 14 percent in 1990, a reduction of almost 65 percent (see Table 6.4). At the same time, the incidence of urban poverty declined by more than 55 percent. The number of poor people also declined, but by lesser proportions because of the impact of population growth. Country-wide, the number of poor people declined by about 50 percent, consisting of a 60 percent decline in rural areas and virtually no change in the number in urban areas. Thus, while part of the reason for the reduction in poverty in rural areas was increased incomes in agriculture-and this fact is well-documented 76/-part also was due to rural-urban migration. This is evidenced by population shifts Table 6.4: TRENDS IN THE INCIDENCE OF POVERTY 1976 1978 1980 1984 1987 19901ia Incidence of Poverty (Z) Urban 38.8 30.8 '9.0 23.1 20.1 16.8 Rural 40.4 33.4 28.4 21.2 16.4 14.3 lotal 40.1 33.3 28.6 21.6 17.4 15.1 Number of Poor Peogle (millions) Urban 10.0 8.3 9.5 9.3 9.7 9.4 Rural 44.2 38.9 32.8 25.7 20.3 17.8 Total 54.2 47.2 42.3 35.0 30.0 27. LI Provisional estimates. Source: 1976 to 1988, Table 1.1 P6 1980 to 1987, Table 1.4 P11. 25/ See, for example, the WDR on Poverty, in which Indonesia is cited as an example of a country where the growth process had a major impact on reducing poverty. This is discussed in more detail in Strateav for a Sustained Reduction in Poverty. Zi7 Detailed analysis of the period 1984-87, for example, reveals that 60-70 percent of the decline in poverty came from households primarily engaged in agriculture. ER130. - 112 - over the period, and by tha relative shift in the locue of the poverty problem. In 1976, 18 percent of poor people were located in cities and 82 percent in rural areas. By 1990, this had changed to 35 percent in cities and 65 percent in rural xreas. Poverty is increasingly becoming an urban problem, particularly on Java, when once it was almost entirely a rural one. More recent calculations of the severity of poverty,, however, indicate that there might have been some underestimation of the rural nature of poverty. 6.8 Although Java, as the main rice-producing area, benefitted most directly from the rice production-led growth in agriculture, the incidence of poverty (19.0) in 1987 was still somewhat higher than the national average (17.4). Because of this and because of its high share of the total population, poverty remains concentrated in Java. Within Java, the poorest areas are: upland areas (particularly the limestone hills of Central and East Java, Madura), and those areas relatively far away from urban areas, and fishing villages along the coast of North Java.77/ Table 6.5: REGIONAL LOCATION AND INCIDENCE OF POVERTY, 1987 (percent) Population Regional share of Regional incidence share total poor people of poverty Java 60.5 66.0 19.0 Sumatra 20.1 11.2 9.7 Sulawesi 7.0 9.0 22.4 Kalimantan 4.9 2.5 8.9 Other 7.5 11.3 26.2 Total 100.0 100.0 17.4 Source: Population share 1987 calculated from 1985 base in the Bank report "Strategy for Sustained Reduction in Poverty", (SSRP) and population growth rates from 1985 to 1990 in (Economic Report) ER159. Regional shares from SSRP. Regional incidence calculated from cols. 1 and 2 and national average of 17.4. 6.9 There is considerable variation among provinces in the incidence of poverty, mean income per capita, and the dependence upon agriculture (Table 6.6). The incidence of poverty remains high in thp provinces of Java, but also on Nusa Tenggara, East Timor, Sulawesi, and Irian Jaya. A strategy which reduced poverty on Java may be much less relevant off-Java and in the Eastern 77/ A detailed analysis of the location of the poor, of the characteristics of their communities, and of strategies for reaching them is currently being completed in Center for Agro-Socio-Economic Research (CASER), Bogor. The results are expected to be available in due course. - 113 - Table 6.6s PROVINCIAL VARIATION IN SOME MEASURES OF POVERTY, 1987 Mean income Incidence Province per capita of poverty Rp/month (percent) Aceh 19,702 12.50 N. Sumatra 17,964 22.32 W. Sumatra 22,155 6.98 Riau 20,657 7.85 Jambi 20,120 6.48 S. Sumatra 20,929 15.02 Bengkulu 19,837 8.77 Lampung 17,428 34.41 W. Java 18,365 22.97 C. Java 15,407 40.95 Yogyakarta 17,681 25.19 E. Java 16,840 38.83 Bali 19,236 39.99 W. Nusa Tenggara 15,214 47.05 E. Nusa Tenggara 16,315 53.00 E. Timor 18,697 45.27 W. Kalimantan 17,385 27.64 C. Kalimantan 18,524 17.65 S. Kalimantan 18,076 15.37 E. Kalimantan 24,979 8.17 N. Sulawesi 21,881 27.72 C. Sulawesi 21,766 29.77 S. Sulawesl 16,564 42.01 SE. Sulawesi 15,310 55.81 Maluku 18,093 24.95 Irian Jaya 17,402 40.96 Source: Data from 1987 Susenas, available in Monika Happi and Martin Ravallion, "The Sectoral Structure of Poverty During an Adjustment Period," World Bank, mimeo, Revised January 1991. Islands where farm families have an inadequate resource base. Without a detailed study on development options for these areas, it is not possible to make alternative recommendations. However, it is clear that there is a coincidence between regional development and poverty reduction on some of the Eastern Islands.78/ There are opportunities in tree crops, fisheries, livestock and forestry, off-Java. The reduction of rural poverty off-Java 781/ The effectiveness of regional targeting as a poverty strategy has been evaluated by Martin Revallion. See "Poverty Alleviation through Regional Targeting: A Case Study for Indonesia", mimeo, World Bank (undated). - 114 - requires agricultural growth, since the poor in these areas have limited off-farm income possibilities. The issue is one of devising approaches which do not deplete the fragile resource base and which generate developmental linkages to existing local economies. Enclave-type development is to be avoided as a most inefficient poverty alleviation strategy. Poverty has been transformed from a general, pervasive problem to a more particular and localized one. Correspondingly, some changes in the strategy for reducing poverty further are called for. 6.10 Although direct evidence is lacking, the composition of economic petivities in rural areas has certainly changed over the past two decades. Economy-wide, the share of agriculture in total economic activity has declined from 56 percent in 1965 to 23 percent in 1989.79/ Even in rural areas, this report's estimate is that agricultural activities contributed only 36 percent of rural GDP (see Appendix G, Volume II) in 1990, almost certainly down from the time when the rice self-sufficiency campaign was initiated. This implies that strategies for both growth and poverty alleviation in rural areas need tc foster (or remove hindrances to) the development of non- agricultural activities and should include policies to facilitate the normal developmental transition and movement of people from rural and agricultural activities to urban and non-agricultural pursuits. Rural-urban migration, by moving people from lower-productivity activities (measured by lower incomes) to higher productivity ones, contributed about 18 percent of total per capita income growth in 1990. Within rural areas, the impact of the outmigration to cities was estimated to contribute as much as 30 percent of the growth of rural per capita incomes. Finally, if the growth rate of non-agricultural activities in rural areas were brought down to zero (for example, by prohibitions on the transfer of land and water to non-agricultural use in rural areas), the rate of growth of per capita rural incomes would be brought down to near zero (see Appendix G, Volume II). All these considerations point to the importance of non-agricultural activities and policies in increasing incomes and reducing poverty in rural areas. This does not, of course, reduce the importance of a concurrent reduction in rural poverty, which is needed to prevent the urban poverty from getting worse. Successful agricultural development is needed to generate rural prosperity which, in turn, generates off-farm jobs. 6.11 Looked at more narrowly, the poor in rural areas are increasingly those left behind by the growth process, are located in disadvantaged areas and lack the ownership of good agricultural land. While rapid ra.es of per capita income growth will continue to be the cornerstone for poverty alleviation in Indonesia, both rural and urban, it is doubtful whether agricultural growth alone will have a significant impact upon the remaining pockets of poverty in rural areas in Java. Indeed, it seems unlikely that there is much future for many communities in resource-poor areas 81/ in their traditional activities. Movement to other areas, including cities, other islands, or other localities where employment opportunities exist may be the only solution. In this connection, the experience of the now-industrialized countries is relevant: reductions in rural poverty in Appalachia in the USA and the highlands of Scotland occurred mainly from the migration of people to 79/ WDR 1991, p.208. - 115 - better economic opportunities elsewhere and not from economic development in the poor areas. As part of a strategy to alleviate poverty at Indonesia's stage of economic development, it is important to identify the remaining concentrations of poverty, and to assess whether the communities have an adequate land and water base to permit being liftel out of poverty through improvements in their existing activities, by adding new activities, or whether geographical movement of a significant proportion of the local population is a necessary condition for economic betterment.80/ If the last is the case, the efficacy of ameliorative measures in situ must be questionedt thp danger of bringing about improvements which stop short of solving the problem is that the problem may be perpetuated by making people less willing to undergo the larger and more disruptive changes needed for significant and sustainable income increases. 6.12 The elements of an anti-poverty strategy for Indonesia, both rural and urban, were set out in a recent Bank report.81/ The approach outlined in that report is reinforced here. In particular, non-agricultural activities should be permitted to evolve, land use should not be overly regulated (para. 3.32), and the growth of processing activities should not be inhibited through licensing restrictions on the expansion of capacity (para. 5.6). Further, education and human resources development are not only necessary for sustained economic growth, but if properly targeted to disadvantaged groups, can also facilitate their movement to other, more remunerative economic activities. This is not to detract the importance of agricultural growth, which has powerful multiplier effects on rural non-farm economy, that lead to additional employment and income earning opportunities for the poor. Impact on the Environment 6.13 While the forestry subsector is not reviewed in this report, the low rate of growth of forest products assumed here is associated with sustainable yield policy. The sources and costs of deforestation are briefly described in Box 6.1. The foodcrop production strategy is based essentially on intensity increases (on mainly existing land areas) and yield increases (mainly new varieties) rather than on a major expansion of land area and/or major increases in the use of agricultural chemicals. In addition, the report suggests the expansion of irrigation within existing schemes and no expansion on swamps. Thi need for sound crop rotations and adequate crop management practices is emphasized to prevent degradation of the paddy environment under intensive and continuous cropping. Likewise, improved soil management for watershed protection is needed (Box 6.2). When appropriately sited and well managed, tree crop production can utilize, and in fact, stabilize marginal land in critical areas for which few other sustainable land uses may be available. It is, therefore, an environmentally-friendly production-increase strategy. 80/ A useful start in the identification process has been made recently at CASER in Bogor. No results are available at the time of writing. 81/ Indonesia: Strateav for a Sustained Reduction in Poverty, World Bank, 1990. - 116 - Box 6.1: SOURCES AND COSTS OF DEFORESTATION Indonesia has the largest remaining area of natural tropical forests of any country in Asia, currently estimated between 100 and 114 million hectares, covering 53-60 percent of the total land area. This natural forest area is second only in size to Brazil's, and Is extremely rich in terms of biodiveraity. With only 1.3 percent of the earth's land surface, Indonesia contains many species of plants and animals found nowhere else in the world. It also has the world's longest list of species threatened with extinction. Unfortunately, deforestation is taking place at a rate estimated variously at between 700,000 and 1.2 million ha per year. Forest resources have been contributing substantially to Indonesia's robust growth in recent yearsa export earnings from timber products are currently approaching $4 billion a year, due mainly to its almost 50 percent share of the world plywood market. In 1990/91, the share of forestry in Indonesia's total earnings from exports was about 14 percent or approximately a quarter of non-oil exports. Furthermore, the forests are a source of a wide range of non-timber forests products, such as rattan, resin, turpentine and bamboo. However, harvesting of timber is not the only-or the major-cause of the rapid deforestation, as shown by the table below: SOURCES OF DEFORESTATION (hectares per year) Source Best Estimate Ranne Smallholder conversion * 500,000 350,000 - 650,000 Development projects 250,000 200,000 - 300,000 Logging 80,000 80,000 - 150,000 Fire Loss 70,000 70,000 - 100,000 Total 900,000 700.000 - 1.200.000 Source: Indonesia: Sustainable Development of Forests, Land and Watir, (1990). The greatest uncertainties in these estimates relate to the loss of forest due to shifting cultivation and smallholder conversion outside of development projects. Recent studies Indicate almost 30 million hectares are under shifting cultivation or under brush and secondary forest, which usually signify previous agricultural use. If this area Is expanding at only 2 percent annually (about half the rate of population growth in the provinces with large areas of shifting cultivation), then deforestation due to various types of smallholder forest couversion in the Outer Islands would be in the order of 500,000 ha/year, as shown In the table. Of this, perhaps half could ultlmately regenerate as secondary forest, to be cleared again by smallholders when fertility Improves, but virtually all would be lost to timber production. The estimates for development projects Include forest conversion for 001- sponsored tree crop and transmigration programs. In recent studies of wood processing, deforestation directly due to logging was estimated at about 10 percent of the annual area logged. Logging is frequently Identified as an indirect agent of deforestation because it opens logged over areas which might have regenerated if left undisturbed, to surrounding populations via construction of logging roads, and may add to that population by providitg temporary employment to immigrant workers. It is difficult to estimate the extent to which encroachment on forested areas which occurs after logging would have proceeded even without logging, due to population and income factors. The estimate for forest fire destruction does not lnclude the recent Kalimantan fires, and may therefore be low. - Continued - - 117 - Box 6.s: SOURCES AND COSTS OF DEFORESTATION (Cont'd) Deforestation at this level has some very high costs. Net lose to the economy in terms of all merchantable forest products could amount to as much as $1 billion each year. In addition to being costly to the economy in terms of foregone timber production, deforestation has a number of negative consequences of national and international concern. Catcbment (soil and water) values off-site can be significantly affected by deforestation. Large-scale clearing for agriculture produces smoke and carbon dioxide, which are considered to be major contributors to global warming. Forest destruction also leads to loss of biodiversity. Because Indonesia's tropical forests play such a critical role in terms of both biological diversity and economic development, they must be conserved at the same tlme they are utilized for their production capability In a truly sustainable manner. These are challenges which vill require the best technical and managerial capability that can be brought to bear, Implying a major international effort. As such, these issues will be addressed in a separate Forestry Sector Review, to be undertaken by the Bank in end 1992. 6.14 Depletion and pollution problems exist in some traditional in-shore fishing areas on the north coast of Java, south coast of Sulawesi, and in the Malacca strait (paras. 3.58-3.61). These fishing communities need to move to other activities or other locations. There is also a need to monitor expansion of fisheries development in the eastern islands, and to effectively utilize the resources for local development. 6.15 Regarding the water quality (paras. 3.22 and 3.23), there is urban- and industrial-based water pollution, which is becoming critical in some areas. The bulk of the population lacks safe drinking water, even in the urban areas. There is an increasing danger of saline intrusion to drawn-down water tables in some urban areas-especially Jakarta. As a result, there is a need to divert water from irrigation (saved by better O&M and management). There is no evidence yet of significant water pollution bv agriculture: pesticides and fertilizers. A shift to Integrated Pest Management should help reduce this risk in the future. 6.16 A major environmental risk is uncontrolled effluents from expanded agro-processing and other industry in rural areas. This risk can be minimized by the regulatory and fiscal (such as "polluter pays fines") policies, but these are not discussed in this report. Future of Aariculture in Structural Transformation 6.17 The transformation of the structure of production during economic growth is a stylized fact of economics: the proportion of total output from agriculture contracts, while manufacturing and services expand. The faster the rate of overall growth, the faster this process occurs. The transformation of the structure of output coincides with a transformation of employment, but the latter tends to lag and sometimes entails adjustment problems. 6.18 From the perspective of the agricultural labor force, the process of structural transformation is not necessarily benign. On the one hand, expanding opportunitias in the non-agricultural sectors may lead to increased - 118 - Box 6.2: SOIL MANAGEMENT FOR WATERSHED PROTECTION Coneern over upland degradation on Java led in the 19708 to the development, with international technical assistante, of a package of soil conservation practices. These were borrowed from temperate countries, and although modified for Java's steep slopes and intense tropical rains, they still called for heavy investment in physical structures-minor dams, land shaping, terrace construction, and storm flow waterways-with high costs ranging from $400 to $1,000 per hectare. To encourage adoption of these expensive practices, as elaborate system of costly demonstrations, subsidies, extension, and direct government construction was created. It was insufficient, however, because the structural measures proved unprofitable in practice on farmers' fields, took significant areas of land out of cultivation (for waterways), required large amounts of labor and close cooperation by adjacent farmers, and required considerable maintenance and upkeep. Only subsidies in cash and kind lured farmers to adopt portious of the proposed packages, but they paid little attention to the exacting technical standards required for effective cot -rvation or profitable farming on treated land, and ignored unsubsidized maintenance, scrimped on waterway construction (which can lead to massive failure of the terrace structure in heavy rains). Upland areas, meanwhile, continued to degrade. Efforts were undertaken to develop a more sophisticated and flexible approach to conservation as recognition of the failure of the standard technical package grew. KEPAS, the Indonesian Research Group on Agro-ecosystem, was formed in 1983 in part to focus on socially and ecologically sound agricultural development of marginal lands and It had an important influence in broadening the technological approach to soil conservation in Indonesia. Attention shifted from structural approaches to a broad range of farmer controlled and farmer instituted agronomic and vegetative measures including contour hedges, agroforestry, intercropping, and other practices. The understanding and appreciation by forestry staff of the concerns and interests of farmers has also increased. An array of simple low-cost approaches to soil conservation already exist that are broadly appzopriate for many areas where degradation is a problem. Yet many studies are revealing that the profitability of such technique can vary significantly for farmers depending on their individual circumstances, such as field slope, crop mix, and labor availability. No single approach will be the best for all farmers in the area, and conservation programs based on production of one technique generally fail to achieve broad farmer participation. Greater success results when conservation programs and extension services make information available on a menu of techniques adapted to local circumstances, from which each farmer can select to get the best results under their specific conditions. rural-urban migration and rising real incomes as well. Such examples are often described as "pull" factors from outside agriculture. On the other hand, when worsening rural impoverishment is the mechanism driving labor out of agriculture ("push" factors), the process of structural transformation implies hardship for many people. 6.19 Results of the past structural transformation (Chart 6.1) are H, Volume II. Charts 6.2 and 6.3 simulate the future path of agriculture's share of non-petroleum GDP and total employment, respectively. The share of agriculture GDP can be expected to decline to about 15 percent and its share in total employment to about 40 percent,82/ by the year 2010. Case 1 assumes continuation of the past observed rates of change in agriculture's terms of trade, the rate of technical change in agriculture, and the 82/ MOA estimates that the share of agriculture in total employment could be about 30-35 percent by the year 2010. y *on jsaeum GDP at pi (S0) - A(S -.0.8 0.7 0.. 0.. 0.6 1I .2t~~~96 Figure 6.2: MdmsMa: Agdiculs prdcted share of non.pstobunm GDP at ounent pdcs, 1982015 0.3 0.25 0.15 t~~~~~~~~~~~~~~~~~~~~~~~ lo 0.1 0.05 1950 199 19101 1992 1993 1994 1915 19960 19t 1996 1999 00o 2001 2002 2003 2004 2005 2006 2007 2006 2009 2010 2011 2012 2013 2014 2015 Years casel (0 Cas20 Figure 6.33: Indonesa: Agrlculurfs predted shae of total employment, 188-2015 0.6 0.5 0.4 0.3 0.2 - 0.1 1988 1980 1990 101 1992 1993 1994 10S 1906 1997 1998 1999 2000 2001 2002 2003 2004 2006 2006 2007 2008 2009 2010 2011 2012 2013 2014 2016 Years (+c8$O@ Ocase2 I c ft "31 - 122 - capital/labor ratio. Case 2 assumes that the rate of growth of the capital/labor ratio falls to half its past value. These results suggest thatt (a) Capital accumulation, rather than relative price movements, has been the principal driving force behind the decline in agriculture's share of GDP. Moreover, relative price movements have played little role in agriculture's declining share of total employment. The fear that declining terms of trade against agriculture might cause workers to be "pushed" out of agriculture, and lead to open unemployment, may be misplaced; (b) Attempts to reduce labor migration out of agriculture through price intervention will be largely ineffective. Such policies would benefit owners of fixed agricultural factors, but they would have only a small effect on agriculture's share of total output and virtually no effect on rural landless or the movement of labor out of agriculture. Agriculture's employment share is quite in3ensitive to movements in relative commodity prices; (c) Continued economic growth is expected to result in further declines in agriculture's terms of trade. The rate of this decline will depend also on Indonesia's foreign exchange earnings from petroleum exports, which are virtually unpredictable, and on the rate at which these revenues are absorbed into the domestic economy, which is determined by Indonesia's macroeconomic policies. The faster the rate of absorption, the faster agriculture's terms of trade will decline. Such a decline in agriculture's relative price can be expected to produce demands for intervention in the prices of agricultural commodities. Strong pressures of this kind have been observed in the rapidly growing economies of Taiwan and Korea and are already becoming apparent in Thailand, which is growing even faster than Indonesia. A sound agricultural development strategy can help raise farm productivity and thereby offset the terms of trade losses; (d) A slowdown in the rate of technical change in agriculture has been feared in some quarters. This would have significant effects on agriculture's share of total output, causing it to decline more rapidly than otherwise, but would have negligible effects on agriculture's share of total employment. The reason is that tes mical change in agriculture has caused factor productivity, including labor, to rise but it has also been strongly labor-using relative to other factors, especially land. Changes in the rate of technical change in agriculture thus have significant effects on agriculture's output share, but small net effects on its employment share; (a) Continued accumulation of capital relative to labor li clearly essential for sustained economic growth. This capital accumulation vill have significant effects on agriculture'as share of both GDP and employment, creating new employment opportunities outside agriculture. The mechanism through which resources, especially labor, will be drawn out of agriculture will be overwhelmingly - 123 - "pull' rather than "push" factors. Capital accumulation raises the productivity of labor elsewhere in the economy, creatilng new opportunities for agricultural workers. Agricultural development itself makes a positive contribution towards generating rural prosperity that in turn generates off-farm employment opportunities. This process expands the set of alternatives open to the agricultural workforce rather than reducing them. It need not create a policy dilemma and need not be resisted. This process will be accompanied by continued reductions in the incidence of poverty, especially In rural areas. Policies designed to reduce the rate of mwvement of labor out of agriculture would in general inhibit (see Appendix G and Appendix N, Voluie II) rather than promote economic growth and poverty alleviation; (f) It Is essential that the continued movement of labor out of agriculture not be misinterpreted as a symptom of rural malaise, which should be resisted by the government. The continued movement of labor from agricultural to non-agricultural forms of employment doe not indicate a failure of Indonesia's agricultural sector to "absorb" labor, or a failure of agricultural policy, Rather, it will be a natural consequence of a successfu3 economic development strategy. It should be facilitated rather than resisted; (g) In the literature dealing with agricelture's role in the Indonesian economy, heavy emphasio has been placed on agriculture's Importance in "absorbing" labor. But agriculture has actually released labor, not because of a failure to "absorb" it, but because of the expansion of employment opportunities elsewhere. Policies should not focus on finding ways for agriculture to absorb surplus labor. Rather policies should enhance the productivity of labor throughout the economy This is the key not only to economic growth but also to continued poverty alleviation; (h) The epansion of employment opportunities outside agriculture and the resulting movement of labor to take advantage of them does not necessarily Imply migration from rural to urban areas. This is particularly lmportant, because Indonesia's urban centers are already congested. Many non-agricultural employment opportunities will be created In rural areas. They include light manufacturing, agro-processing, marketing of both agricultural and non-agricultural goods, and many other forms of services. Moreover, seasonal labor migration from rural to urban areas and Lack again Is a particularly notable feature of Indonesia's labor marketes and (1) Policies designed to promote the development of non-agricultural sativities In rural areas can reduce the pressure on the large urban centers which would otherwise be a consequence of Indonesia's structural transformation. Such policies include the provision of adequate road, and telecomunications systems in rural areas, and further deregulation of the financial services sector to permit theso services to be provided adequately outside the urban centers. Moreover, by reducing the degree of overall government regulation of economic activity, the government can reduce the tendency for Industrial enterprises to locate close to the (urban) administrative conterso - 124 - VIZ. AGENA FOR T FUTURE 7.1 Ovrvle. This chapter collates *ome of the major priorities for the investment, policy, and tnstltutional strategies. Theme strategies are xpected to help the agriculture sector to position *tself for the challenges and opportunities which lie ahead. Actions by GOI, on the domestic front, as well as external donor assistance strategies are discussed. Public Investment prioritiei 7.2 The pattern of public expenditures needs to be altered, with lse spending on fertilizer subsidies and new irrigation developments, and more on research, extension and Infrastructure. 7.3 Investment in research should continue to have high priority. The shifting of the rice yield frontier will probably come from: (a) development and adoption of never varieties Including hybrid rice (next 10 years); (b) changes in plant architecture In the long-term (10-15 years) by decreasing the number of tillers but with larger panicles; (c) Incorporation of peost resistance and other characteristice, including through biotechnology, In the medium and long-term to provide sustainability of yield; and (d) Improvement of crop management practices, l.oe., direct seeding, increased plant population, judicious use of pesticides, better placement of fertilizer, and incorporation of organic matter to improve soil health, and Improved crop rotation practices. Research on rice varieties with lesser water needs and greater drought tolerance should be a priority. Use of leguminous crops In rice rotation can halt degradation of paddy environment under Intensive cropping systems. The tolerance of these crops to acid soils and drought conditions may require testing. 7.4 Corn improvement programs entailing research on hybrids, should be vigorously pursued and linked with crop utilization in feed and agro- Industrial purposes. The economic viability of ougarcane production In rainfed areas should be examined. The quality of horticultural crops noeds improvement. Pests affecting herbs and spices may pose problems. Research on the control of animal diseases, Improvements in animal husbandry and In the provision of more and better forages for the growing livestock subsector Is also needed. Commodity research needs to be undertaken In the context of farming systems, based on agro-ecological zones. Thus, greater cencentration on non-rice activities vill require not only a broader range of skills, but also a more geographically dispersed research infrastructure. 7.5 Adoption of future technologies will require Improved farmer training. The delivery of the extension services needs to be made more effective. Good planting material (on a cash basis) and strong extension support to a large number of tree crop smallholders will also be needed. 7.6 With regard to bringing new land under irrigation, the Issues are costs and the realization of high productivity on the newly Irrigated land because of soil, terrain and hydrological constraints. Moreover, self- sufficiency In rice can be maintained through introduction of hybrid rice and new varieties without major program to expand cultivated area. Until these - 125 - newer varieties are developed and disseminated, annual irrigation expansion may be needed on some 35,000-50,000 ha, during the next 5-year plan period. Policies should focus on improving research and extension, improving the efficiency of water use, water quality and improved management of water and land resources. This does not preclude the potential for groundwater development by the private sector, which needs to be realized. Actions on the Policy Front 7.7 Supportive macroeconomic policies, including adoption of flexible exchange rates, fiscal and monetary policies which contain inflation9 and liberalization of foreign trade, should be continued. These policies are necessary to maintain the international competitiveness of the sector and to spur domestic growth. 7.8 With regard to sectoral policies, input subsidies should be phased out (in particular, a phase out of the fertilizer subsidy by 1995) and resources should be reallocated to research and infrastructure. An approach may be to utilize the resources for poverty alleviation and regional balance, as needed for the Outer Islands. Alternatively, savings, if any, could be used to contribute to macro-economic stability. A further dismantling of the administered price and regulatory trade system.s is also needed. 7.9 Regarding rice policies, this report contends that: (a) the distribution of rice to budget groups involves unnecessary marketing costs since rice is re-sold on the domestic market. Also, BULOG purchases are destabilizing when domestic rice supplies are short. This program should be phased out gradually over a 3-year period and as part of a civil service pay reform package. An alternative would be to change the target group, to low income households as part of a poverty alleviation program; (b) the role of the private sector in marketing rice would be increased and costs reduced by limiting interventions to those areas, where competition in the market needs to be ensured. This would eliminate the need for several sub-DOLOGs. To provide incentives for private storage, intervention prices should be increased during the first few months after the main harvest; and (c) the domestic price should continue to be maintained at world parity. Ceiling prices should be adjusted annually to reflect changes in world prices, using a moving-average formula of perhaps 5 years. The intervention price should be based on the ceiling price after deducting margins for storage and transportation costs. 7.10 Protection of feed ingredients, soybeans and soybean meal for example, taxes some of Indonesia's most promiaing agro-processing industries, including feed milling, intensive poultry production and shrimp farming. High feed costs also tax the pork, dairy and beef industries. Labor-intensive tempo and tahu producers are taxed by high soybean prices. It is, therefore, recommendedt (a) that licensing restrictions on soybean imports be eliminated and replaced with a tariff identical to that for soymeal; (b) that soymeal imports remain deregulated and opened to the private s.ctor under the same tariff structure as for BULOG; (c) that the tariff on soymeal be as low as possible to encourage the development of feed milling and livestock Industries; and (d) that the fee structure for the crushing mill be eliminated and the industry opened for private investment and increased competition. - 126 - 7.11 Sugar is another highly protected commodity and is a key ingredient in many processed food products. Deregulation should initially focus on relaxation of forced culsivation by farmers, on state ownership of the milling industry and BULOG's control over the distribution of refined sugar i.e., opening of the industry to private investment and increased competition. An open tender system would eliminate the high commissions paid to agents to handle sugar imports. Over the long term, sugar prices should be lowered to import parity. 7.12 With regard to wheat and flour pricing and trade policies, it is recommended thct flour prices be set at world market parity. In case there is a rice deficit, Indonesia would be better off importing wheat, which is a cheaper calorie source of food energy. If a rice surplus develops, Indonesia would be better off exporting rice at higher prices and gaining the value- added from processing imported wheat at home. This report contends that there is no reason for subsidizing wheat to nills while imposing a surcharge on consumers. Major deregulation options include: elimination of licensing controls over flour imports, thi administered price system, investment restrictions on flour milling and all licensing requirements in the distribution chain. BULOG's monopoly control over imports should be eliminated and replaced with a tariff, if necessary. 7.13 Regarding cassava, the Government should eliminate the implied subsidy to non-EC markets and garner part of quota rents (which presently accrue to cassava exporters in Indonesia and importers in non-EC markets) by auctioning the EC quotas. 7.14 In order to alleviate yov...rty, the GOI needs to devise approaches which do not deplete the fragile resource base and which generate developmental linkages to local economies. Growth of non-agricultural activities would facilitate an increase in incomes and a decrease in poverty in rural areas, particularly in Java. The reduction of rural poverty off-Java wil require strong agricultural growth, since the poor in these areas have limited off-farm income possibilities. Policies should focus on the provision of roads, and telecommunication systems within rural areas and deregulation of the financial services sector to permit the expansion of these services outside the urban centers. By decreasing the dagrRe of overall government regulation of economic activity, GOI can eliminate the tendency for industrial enterprises to locate close to urban, administrative centers. Actions to Strengthen/Foster Institutions 7.15 Future agriculture development strategies should deal with research, extension and adoption of economically viable technical packages. There will be a continuing need for more and efficient coordination between AARD, extension organizations and farmers. 7.16 The AARD needs to upgrade its information technologies particularly networking between regional research programs, IARCs and other research organizations. The increasing role of biotechnology in agriculture adds another dimension to modernizing Indonesia's research program. - 127 - 7.17 Regarding extension, a decentralized approach based on provincial and regional resources needs to be fostered. Skills improvement and greater use of modern communications technology as part of the outreach service to farmers, should be undertaken. Separation of accountability between AARD and extension agencies does not serve the farmer who is the ultimate adopter and risk taker. 7.18 The Government's regulatory role with respect to the environment is likely to be enhanced in the future. In addition to appropriate pricing of land, water and forestry resources, regulatory standards may be needed to control effluents from agro-processing entering both fresh and salt waters, to prevent depletion and pollution problems in fishing areas and to improve water quality generally. More specifically, with regard to the land policy framework, a recent Bank report has proposed adjustments to policies requiring a change in legal and regulatory framework (including a simplification of land regulations and, over a longer-term, removal of restrictions on land lease periods and ownership of land rights, needed in particular, to stimulate private investment in agro-processing), improving land information systems, and formulating a transparent resettlement policy at the national level, based on fair compensation. Likewise, with regard to Indonesia's tropical forests (an area not covered in this report), they must be conserved at the same time they are utilized for their production capability in a truly sustainable manner. These are challenges which will require the best technical and managerial capability that can be brought to bear. As such, these aspects will be addressed in a separate Forestry Sector Review to be undertaken by the Bank at the end of 1992. Also, an array of simple low-cost approaches to soil conservation including farmer-controlled and farmer-instituted agronomic and vegetative measures such as agro-forestry, inter-cropping, and other practices will be needed, in the uplands to protect watersheds. Regarding water pricing, the longer-term strategy should be to charge water user groups the wholesale cost of water at secondary outlets. In the meantime, the collection of the irrigation service fee on an area and crop basis, and the turnover of small schemes to the water users associations, should be extended on a nationwide basis. 7.19 While the Government should continue to invest in infrastructure to enhance Rrivate-sector development, GOI may want to revisit its role in agricultural production, marketing and input supply. PTPs should enter into joint ventures with the private sector, and eventually privatize, in order to improve management, efficiency, and gain access to financing. The future role of BULOG in the trade, domestic distribution and storage of rice and for the other commodities is discussed in Section V. 7.20 Regarding input supplies and support services, GOI may want to privatize profitable urea factories and induce greater competition in the wholesale and retail distribution of fertilizer. The roles of public and private sectors in seed production and marketing (including an improved access and provision of planting material to the tree crop smallholders) need to be redefined, and the policy guidelines (including a phase out of seed subsidies) conducive to privete-sector involvement developed. GOI must monitor the vested interests of and abuses by the private sector in promoting pesticides, which have adverse environmental and health impacts. Specialized IPM training should be given a priority, within the context of an improved extension - 128 - approach. Use of small tractors, pumps, sprayers, harvesting and threshing equipment is likely to increase with higher wages in agriculture and increase in off-farm employment. Restrictions on private-sector manufacturing and marketing of such equipment should be relaxed. 7.21 GOI may also wish to consider creating a private-sector liaison unit attached to the DG-AARD office, with responsibility for screening AARD research findings, priorities and research programs relevant to private sector interests. Linkages with research entities, particularly universities and private laboratories need to be strengthened. It may also be worthwhile to identify efforts where the private sector is less likely to be involved, e.g., the development of varieties suitable for acid soils and drought conditions. On the other hand, the Government plans to get large private commercial firms to establish rice plantations should be reviewed very carefully in view of: (a) possible adverse effects on the environment, particularly land and forest use; (b) "unequal" contracting arrangements with the "small" farmers; and (c) financing arrangements if these entail a subsidy or a tax shelter from the Government. Areas Reauiring External Donor Assistance 7.22 External donors should assist the GOI with financing, and support for policy and institutional reforms, in the following critical areas: (a) natural resource management-land, water and forestry resources-to support sustainable development; (b) research and extension, to facilitate future growth and diversification of the agriculture sector; and (c) poverty alleviation strategies, in the form of targeted interventions in specific geographical areas and/or subsector development. Areas Requiring Further Work 7.23 The following areas may require GOI (and donors) to undertake further in-depth studies: (a) an assessment of the appropriate farming systems and of the export market requirements and potential for horticultural products; (b) an evaluation of the economics of growing sugarcane in rainfad areas; (c) a fisheries stock assessment to establish maximum sustainable yield for different commercial species; (d) an assessment of the constraints to, including livestock diseases and lack of animal husbandry, as well as an evaluation of the export market requirements and the potential for livestock products; (e) an evaluation of inter- and intra-island trade restrictions and local monopolies, as well as an analysis of the protection structure for the processed commodities; (f) an assessment of the impact of higher wages in agriculture and an increase in off-farm employment on mechanization, and the impact of mechanization, if any, on the future size of land holdings; and (g) an identification of Lhe remaining pockets of poverty and the requisite ameliorative measures. - 129 - List of References Asian Development Bank. 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