Report No. 1647-IND Problems and Prospects for Industrial Clevelopment in Indonesia (In Two Volumes) Volume II: Industry Surveys May 25, 1978 Industrial Development and Finance Department Industrial Projects Department FOR OFFICIAL USE ONL'Y Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency: Rupiah (Rp) US$1 = Rp 415 (January 1978) Rp 100 = US cents 2.4 Rp 1,000, 000 = US$2,409 PRINCIPAL ABBREVIATIONS AND ACRONYMS USED BAPPENAS Government Planning Agency BKPM Badan Koordinasi Penanaman Model (Investment Coordinating Board), also ICB BPS Biro Pusat Statistek (Central Bureau of Statistics), also CBS CBS Central Bureau of Statistics GOI Government of Indonesia ICB Investment Coordinating Board IDFC Indonesian Development Finance Corporation KIK Kredit Investasi Kecil (Small-Scale Investment Credit Program) KMKP Kredit Model Kerja Penanaman (Working Capital Credit Program) NAFED National Agency for Export Development PDFCI Private Development Finance Corporation of Indonesia PLN State Electricity Corporation PMA Penanaman Modal Asing (Foreign Investment Projects) PMDN Penanaman Modal Dalam Negeri (Domestic Investment Projects) FOR OFFICIAL USE ONLY PROBLEMS AND PROSPECTS FOR INDUSTRIAL DEVELOPMENT IN INDONESIA Volume II: Industry Surveys Table of Contents Page SUMMARY i VI. MECHANICAL WOOD PRODUCTS INDUSTRY 1 Introduction 1 Forest Resource Base 2 Industrial Development 5 Development Prospects 9 Conclusions 14 VII. THE PULP AND PAPER INDUSTRY 16 Introduction 16 Structure of the Industry 16 Conclusions 33 Recommendations 34 ANNEX THE DEVELOPMENT POTENTIAL IN THE PULP AND PAPER SECTOR 35 VIII. THE ENGINEERING INDUSTRIES 58 Introduction 58 Present Status of the Industries 58 Technical Considerations 63 Market Factors 68 Major Constraints on Development 73 Future Trends and Project Identification 75 Areas for Further Investigation 80 Summary and Conclusions 85 IX. THE TEXTILE INDUSTRY 87 Current Status of the Industry 87 Future Trends 96 APPENDICES I. Profit and Cost Calculation of Some Knitting Mills; Cost Sl:ructure of some Spinning Mills II. Cost Calculations of 36" Blended Shirting; Cost Calculation of Cotton Yarn This report is based on the findings of an industrial mission that visited Indonesia in November-December 1976. The mission included: Frederick T. Moore, Chief of Mission, Vladimir Dragomanovic, Economist, Andrew Ewing, Engineer, Yao-Su Hu, Economist, Anthony Johns, Engineer (Consultant), Peter MaCawley, Economist (Consultant), Has Tampubolon, Economist (Consultant). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. PROBLEMS AND PROSPECTS FOR INDUSTRIAL DEVELOPMENT IN INDONESIA Volume II: Industry Surveys Summary Introduction i. The industrial. mission from the World Bank visited Indonesia in late 1976; this report reviews the changes in the structure and per- formance of industry in the prior five years and what may reasonably be acconplished in the next. five to eight years. The report is not primarily concerned with short-run problems, but in order to arrive successfully at the objectives in five t:o eight years, it will be necessary to take some actions to correct situations that have deteriorated and to exploit new opportunities that now exist. ii. This report is in two volumes. Volume I, The Current Situation and Policy Issues, reviews the recent growth of industry, the characteristics of industrial investment, and policy issues concerning the planning for future growth. Volume II, Industry Surveys presents an analysis of four industries: mechanical wood products; pulp and paper; the engineering industries; and textiles. Mechanical Wood Products iii. The policies of the Indonesian Government have been successful in bringing about the const:ruction of substantial new sawnwood and. plywood pro- duction capacity over a relatively short period of time. However, if this capacity and the substantial addition which are planned for the next few years is to be effectively utilized to bring about the desired effect of increasing value-added and employment in this industry in Indonesia, then certain positive steps will have to be undertaken by the industry and by Government. iv. On the basis of this preliminary overview, it has been concluded that such solutions might include: (a) The establishment of an effective export timber marketing board. This Board would initially be -set up by the Government but financed through contributions from industry to establish and monitor quality standards, and to develop mar- kets and marketing channels. The board would - ii - also establish links with major log importing organizations in order to assist in promoting an orderly phasing down of log exports in con- junction with a building up of processed wood exports into the same markets; (b) The establishment of training and other tech- nical facilities designed to assist plants to produce sawnwood and plywood to defined quality standards; and (c) A review of taxing and pricing policies aimed at giving the industry more incentive to produce sawnwood and plywood domestically, and less in- centive to export unprocessed logs. Pulp and Paper v. The main conclusions concerning this industry are as follows: (a) The Indonesian pulp and paper industry has been slow to develop with the result that the country now imports over 80% of its paper requirements. No other country in the world with suitable fiber resources is so dependent on imports; (b) Development of the industry now as in the past is confined to the construction and expansion of very small production units. Although these mills appear to be quite efficiently operated, they could never be profitable if not protected from import compe- tition by a 60% tariff barrier; (c) The protective tariff not only allows the existing industry to keep operating but is also attracting new private capital. New plants are also very small and this strategy is seen to be yielding a negative economic rate of return; and (d) Large plants have been proposed for various locations in the country which would materially improve the domestic supply solution. At current world paper prices these projects are only marginally attractive but rates of return would improve substantially with the higher prices which are projected. vi. Under these circumstances, a number of alternative development strategies could be considered but the one that appears to have the best chance of being effective would be for the Government to: - iii - (a) Form a public sector pulp and paper company which would take over control of the five existing govern- ment-owned pulp and paper mills. The company could be staffed with people from the mills and from the Cellulose Industries Division of the Department of Chemical Industrcies; (b) Empower this coinpany to engage consultants as neces- sary, and to negotiate with the sponsors of the five or six major puLp and paper projects under considera- tion in the country; (c) Select the best project for immediate development and form a partnership with the existing sponsor if this is deemed appropriate; (d) Contract for a bankable feasibility study to secure loan finance for the project. Raise equity through a combination of government grant, funds generated by the existing plants, and contributions from any private partners; and (e) Proceed to implement the project and commence eval- uating a second project. Engineering Industries vii. In the period 1972-1976 the engineering industries have more than doubled in size and becoma wider-based and generally more efficient. However, comparisons of different industries within the subsector indicate that this development has taken place unevenly. In the consumer-based product areas the electronics and automotive industries have expanded rapidly over the period both in terms of output and employment, and are still expanding, though not always in an efficient way. The heavy engineering industries have expanded but excess capacity is widespread and there is currently little growth. viii. The main causes of this apparent imbalance are: low productivity and poor, outdated machinery and equipment; shortage of skilled manpower and the lack of technical and managerial talent; difficulties in obtaining finance at reasonable terms; heavy additional costs which offset any compara- tive advantage from low wage rates; preference given to imported products in the capital goods sector. ix. There is a need to have an overall strategy for developing Indonesia's engineering industries as a whole. Two major studies are recom- mended in this connection to assess possible measures to deal wiith key problem - iv - areas and assist the development of an effective industrial strategy. These are: (1) an in-depth study of the problems in the capital goods sector; and (2) a study of the possibility of developing a strong export business. x. Project areas suggested for early attention include: (a) New Products: woodworking machinery; agricultural machinery; construction equipment; materials handling equipment; valves; specialist vehicles; small petrol and diesel engines. (b) Productivity Improvement: extension of MIDC, linked to a new scheme to train graduate engi- neers. Textile Industry xi. The textile industry has been growing considerably in recent years. Its share in total industrial value added was 11% in 1970 and rose to 17% in 1973. In 1969 the output of knitting and weaving was 450 million meters and increased by 141% to 1,085 million meters in 1975/76. The number of spindles increased from around 482,000 in 1969 to 1,152,000 in 1975/76. This increase in capacity was also accompanied by an increase in productivity. The output per spindle was .07 MT p.a. in 1969, and .10 ton p.a. in 1976. The total capacity of dyeing, finishing and printing amounted to 665 million meters in 1970 and the actual output was 933 million meters in 1975/76. All non- cotton fiber was imported in 1969, but in 1975/76 there were four synthetic fiber making units with capacity totalling 59,000 MT per annum. The growth was also accompanied by the production of new products such as blended and texturized yarn, suiting and shirting, double knit, embroidery, brocade, and laces. xii. Although the industry is in difficult times now, in the longer term, to the mid-1980's the prospects are much more favorable since present per capita consumption is low and is expected to grow steadily. xiii. In an attempt to indicate the relative priorities or comparative advantages within the textile industry, an analysis was made of "represen- tative" projects in weaving, spinning, fiber-making and garment making. The comparative calculations indicate quite clearly that garment making offers the best opportunities for investment within the textile industry, followed by weaving. Both spinning and fiber making appear quite unattractive. The internal rate of return is highest in garment making and the investment cost per job created is the lowest. The sensitivity measures and the foreign exchange effects are also generally the best. On these same points, weaving appears to be a favorable field by comparison to the other two. - 1 - VI. 1IECHANICAL WOOD PRODUCTS INDUSTRY Introduction 6.01 In less than 10 years, log exports from Indonesia have developed from a very small base to the point where the country is now the world's largest exporter of non-coniferous sawlogs and veneer logs. The rapid de- velopment of this position, and the relative importance of Indonesia as a log exporter is revealed by the statistics in the following table: Table 6.1 Major Exporters of Non-Coniferous Sawlogs and Veneer Logs Country Export Volume 1964 1969 1974 (million cubic meters) Indonesia 0.1 3.7 18.0 Malaysia 5.1 11.1 12.2 Philippines 6.1 9.4 4.7 Ivory Coast 1.9 3.3 3.2 France 0.7 0.7 1.5 Other 1/ 6.0 6.9 7.2 World Total 19.9 35.1 46.8 Source: FAO Yearbook of Forest Products, 1974 1/ Including Papua New Guinea, the United States, Cameroon, Congo, and other countries, all exporting less than I million cubic meters annually in 1974. 6.02 The volume of exports from Indonesia peaked in 1973 and subse- quently declined. Most of this decline is due to a general slackening in the demand for timber which can be directly linked to the level of housing starts in Japan and North America. Log export data for recent years are summarized in the following table: - 2 - Table 6.2 Recent Export Figures for Indonesian Logs Year Volume 5 Value (million m ) (US$ million) 1972 14.1 221 1973 18.7 553 1974 17.5 703 1975 13.5 469 1976 1/ 15.0 550 1/ Preliminary estimate 6.03 Almost 60% of Indonesia's log exports are shipped to Japan, 20% to South Korea, and 15% to Taiwan. In these countries the logs are processed into sawnwood, plywood, and manufactured wood products, and in the case of Korea and Taiwan, most of these products are re-exported to the United States and Japan. Korea and Taiwan have become the world's largest exporters of plywood and this entire industry is based on logs from Indonesia, Malaysia and the Philippines. The Indonesian Government has recognized that by ex- porting unprocessed logs, the country is forsaking domestic employment po- tential. Therefore, all timber concession agreements now contain provisions that require the concession holder to provide for domestic processing of certain proportions of the timber harvested within a specified time. 6.04 This chapter examines the structure of the Indonesian timber in- dustry and in particular the extent to which Government policies have been successful in promoting the growth of domestic processing as an alternative to log exports. A brief review of the forest resource base is given followed by a description of the existing industry. Finally the main factors which will determine the direction of future development are examined, including markets, economic aspects and Government policies. Forest Resource Base 6.05 Timber is now Indonesia's second most valuable export commodity (after petroleum products). Attempts have been made to determine the ex- tent of the resource base in order to project how long the current rate of extraction can continue, and although the information is not complete cer- tain indicative conclusions can be drawn. Area of Forest Land 6.06 About 120 million hectares, or over 60% of Indonesia's total land area, is classed as forest land. This is the largest forest resource in Asia and one of the largest in the world. The geographical distribu- tion of forest land is approximately as follows: - 3 - Table 6.3 Oistribution of Forest Land Province Total Land Forest Land Area Area (million hectares) Sumatra 47 28 Kalimantan 54 41 Sulawesi 19 10 Maluku 8 6 West Irian 42 32 Java, Madura 13 3 Bali, Nusa Tenggara 7 2 190 122 Source: Central Bureau of Statistics. Other sources suggest Indonesia's total land area is as much as 202.7 million hectares. 6.07 According to 1973 designations by the Directorate General of Forestry, this 122 million hectares of forest land was categorized as follows: Table 6.4 Forest Land Categories, 1973 Type Area (million ha) (%) Production 35.4 29.0 Protection 11.5 9.4 Production and Protection 4.7 3.8 Bare Land 12.7 10.4 Conservation 3.1 2.5 Not Categorized 54.8 44.9 Total 122.2 100.0 6.08 Up to June 1974, 50.5 million hectares or about 41% of the country's forest land had been surveyed for forest exploitation. Con- cessions for approximately 33.1 million hectares had been granted as follows: - 4 - Table 6.5 Forest Concessions Granted to 1974 Province Area No. of Total Surveyed Forested Concessions Concessions Forest Granted (million hectares) Sumatra 28 16.5 11.9 9.0 115 Kalimantan 41 26.7 19.7 20.2 226 Sulawesi 10 3.7 3.0 2.0 27 Maluku 6 2.6 1.9 1.3 14 West Irian 32 1.0 0.9 0.6 3 Other 5 n.a. n.a. n.a. n.a. Totals 122 50.5 37.4 33.1 385 Annual Allowable Cut 6.09 The total standing volume of logs in excess of 50 cm diameter on surveyed land has been estimated to be approximately 3,600 million cubic meters of timber of the following types: Table 6.6 Estimate of Standing Volume, 1974 1/ Species Volume Percent Total On Cogcessions (%) (million m ) Merchantable Species - dipterocarps 1,760 1,640 49.4 - others 1,090 928 30.6 - ramin 72 72 2.0 - agathis 10 8 0.3 Other species 632 549 17.7 3,564 3,197 100.0 1/ On surveyed areas. Derived from data of the Central Bureau of Statis- tics. 6.10 The annual allowable cut (AAC) in Indonesia is calculated for each concession from the formula: 0.8 x (concession area) x (volume per unit area, 50 cm and over AAC max. = 35 -5- This formula in effect will allow the volume of logs over a 50 cm diameter, except for a 20% safety factor, to be logged over a 35-year period. If timber is considered a renewable resource, the use of this formula implies that if a concessionnaire returns to a logged-over area 35 years after his original extraction operation, the timber less than 50 cm diameter which was left, together with new timber, would have restocked the area. Large scale logging operations have not been going on for long enough to test this assump- tion but there is some evidence to suggest that the character of the second- growth forest may be substantially different from the virgin stands, and the merchantable species now being extracted may not regenerate in substantial volumes.l/ Further examination of this aspect is outside the scope of this industrial survey but it is a matter receiving increasing attention as the areas of logged-over forest land increase. 6.11 In practice, the AAC formula is applied not to the total volume but to 100% of the dipterocarps, ramin and agathis, and 50% of the other merchantable species. Applying the formula in this way to the volume and area figures presented above gives a total AAC of some 50 million cubic me- ters annually. In 1973, the year of greatest logging activity so far, actual extraction was of the order of 21 million cubic meters annually. Within the framework of the Annual Allowable Cut concept therefore, there would appear to be considerable scope for increasing log production from Indonesia's forests. Moreover as more areas are surveyed and brought into production, the AAC as computed by the Forest Department may be expected to increase. 6.12 The forest data for Indonesia is not complete, and some of the figures are suspect. It is reported that certain concession operators may be logging their areas at higher rates than their Forestry Agreements allow. Nevertheless, in the country as a whole, there is little evidence of over- cutting as defined by present forest management policies and it does appear that logging could continue at present or even somewhat higher rates for several decades to come. Industrial Development Sawmilling 6.13 Detailed statistics concerning the number of sawmills in the country are not available but there are reported to be as many as 4,000 "establishments" producing sawnwood. About three-quarters of these are very small operations using hand sawing techniques to produce sawnwood and wood products for local consumption. The 1971 Survey of Large and Medium Scale Manufacturing Industries reported information for 1053 mills as follows: 1/ In Sabah, for example, inventories of areas logged in the 1950's show a preponderance of quite different species from those found in unlogged areas. - 6 - Table 6.7 Sawmill and Wood Processing Plants, /1971 Item Units "large" plants "Medium" Plants Total No. of Plants No. 38 1,015 1,053 Log Input 3 - total m3/A 365,000 775,000 1,140,000 - average/plant m /A 9,600 800 1,100 Production 3 - total m3/A 205,000 410,000 615,000 - average/plant m /A 5,400 400 600 Employees - total No. 6,136 13,005 19,141 - average/plant No. 161 13 18 Value of Output 6,900,000 13,300,000 - total US$/A 6,400,000 6,800 12,600 - average/plant US$/A 170,000 1/ These statistics include some plants which further process sawnwood into various wooden manufactures; however about 85% of the value of the out- put is sawnwood. 6.14 These plants, designated "large" and "medium" in the survey are nevertheless small by world standards. At the time of the 1971 survey, most of the mills of any size were on Java and were sawing teak. About one-half of the mills in the "large" category were operated by Perhutani, a Government timber extraction and processing corporation. Total recorded timber produc- tion in recent years is not reliably available but the available data from three sources are reported in the following table: Table 6.8 Reported Sawnwood Production Year Volume 1/ 2/ _3/ Source 1- Source 2- Source 3- (thousand cubic meters) 1971 1,700 615 1972 - 1,700 1973 249 1,690 1974 545 1,690 1975 569 1976 1,100 (prelim.) 1/ Department of Industry. 2/ FAO Forestry Yearbook. 3/ Survey of Manufactguring Industries. 7- 6.15 As previously noted, the figure of 615,000 cubic meters shown for 1971 by Source 3 (The Survey of Manufacturing Industries) applies to 1,053 medium and large sawmills in operation in that year. It is esti- mated that an additional 3,000 small sawmills were in operation and on the assumption that they processed an average of 200 cubic meters each during the year, total production for that year would be of the order of 1.2 mil- lion cubic meters. The FAO figures are reported as estimated and presumably include an estimate of production from all types of sawmill. The figures from the Department of Industry are substantially less than those from any other source and presumably apply only to those relatively new sawmills which have been licensed by the Department. 6.16 Although accurate estimates of sawnwood production are impossible with the available data, it would appear that in the early 1970's domestic production was between I and 2 million cubic meters annually. In the past 2-3 years the construction of new sawmills has been undertaken as a condi- tion of timber concession operation and in 1976, it appears that these saw- mills produced about 1.1 million cubic meters of sawnwood. New Sawmill Construction 6.17 In 1976, there were 78 sawmills registered in the Department of Industry, 67 of these registered as domestic industries while 11 had some foreign ownership and were registered as such. Most of these plants have been constructed in the paslt 5 years and are not therefore listed in the data of the Survey of Manufacturing Industries presented in Para. 6.13. Some details of these new sawmills are presented in the following table. Table 6.9 Registered Sawmills, 1976 Item Units PMA Plants 1/ PMDN Plants 2/ Number of Plants No.. 11 67 Capacity 3 - total m3 JA 350,000 1,500,000 - average/plant m /A 32,000 22,000 1975 Production 3 - total m3'A n.a. 430,000 3/ - average/plant m3OA --- 10,500 Employees - total No. n.a. 9,700 - average/plant 3/ No. --- 145 1/ Foreign investmeni: projects (Penanaman Modal Asing) 2/ Domestic investment projects (Penanaman Modal Dalam Negeri) 3/ 1975 production statistics were available for only 41 of the PMDN plants. Average capacity utilization in those plants reporting production was 49%. -8- 6.18 These statistics highlight two important features of the Indo- nesian sawmilling industry: (i) There have been substantial additions to capacity in the past five years. These new plants are much larger than those previously in existence and presumably have been built primarily as a result of contractual obli- gations under timber concession agreements; and (ii) There is substantial underutilization of capacity in the sawmilling industry. These aspects are discussed in a subsequent part of the chapter which deals with the present and future prospects of the sawmilling industry. 6.19 From the foregoing information, an estimate of the current struc- ture of the entire sawmilling industry can be developed. All of the data must be considered approximate but in total they probably represented a reasonably accurate picture of the existing industry. Table 6.10 Estimated Current Structure of the Sawmilling Industry Sawmill type No. of No. of Total 1976 Plants Employees Capacity Production (No.) (No.) (m 3) (m3) Hand Operated 1,500 6,000 300,000 300,000 Small powered mills 1,000 13,000 1,000,000 700,000 Modern powered mills 78 9,700 1,850,000 1,100,000 Total 2,578 28,700 3,150,000 2,100,000 Plywood Industry 6.20 Prior to 1973 there were only four plywood plants in the country. Two of these were operated only sporadically and the other two, with a com- bined capacity of only about 20,000 cubic meters annually, produced at 40% or less of rated capacity. Between 1973 and 1976, 16 new plants have been constructed with a3combined annual capacity of 36 million sheets equivalent to about 430,000 m of plywood annually. Plywood production in recent years as reported by the Department of Industry is as follows: - 9 - Table 6.11 Plywood Production Year Sheets Volme (million) (m ) 1973 2.3 27,000 1974 6.0 71,000 1975 10.0 120,000 1976 (prelim) 20.0 240,000 Source: Department of Industry General Assessment 6.21 The past five years have seen impressive growth in capacity in both the sawmilling and plywood industries. In 1976, out of a total log harvest estimated at .1 million cubic metres, about 6 million cubic metres or nearly 30% were processed domestically. Despite this impressive growth there is clearly suff.cient scope for more domestic processing provided markets can be secured and an attractive investment climate established. These aspects are examined in the following sections of this chapter. Development Prospects 6.22 The requirement of timber concession agreements that new timber processing plants must: be built as a condition of operation of the con- cession have been quite effective in bringing about the construction of new domestic capacity.. Furthermore, substantial new capacity is planned as shown in the following table: - 10 - Table 6.12 Proposed New Sawmills and Plywood Mills Item Units Foreign Domestic Total Investment Investment Plants proposed - sawmills No. 25 44 69 - plywood mills No. 6 6 12 Total Capacity 3 - sawmills m3/A 1,400,000 1,300,000 2,700,000 - plywood mills m /A 440,000 80,000 520,000 Employees - sawmills No. 6,600 6,400 13,000 - plywood mills No. 5,000 2,200 7,200 Investment - sawmills $ million 64.3 60.0 124.3 - plywood mills $ million 47.0 17.0 64.0 - Total $ million 111.3 77.0 188.3 6.23 Assuming that these new plants are built, and that by 1980 all new and existing plants are operating at 70% of capacty, total log input to the domestic processing industry will be of the order of 12 million cubic meters annually. If annual log exports stabilize at about 15 million cubic meters, this would imply that domestic processing of Indonesian logs would increase from the present level of 30% to nearly 45%. This figure compares with about 43% in the Philippines and 50% in Malaysia and is clearly a feasible as well as a desirable objective. 6.24 Such progress would be impressive. However at the present time some of the existing plants are operating at substantially less than rated capacity and in some cases are not operating at all. To overcome these problems and to ensure that as new plants come on stream they make an ef- fective contribution to output in this subsector, careful attention will have to be paid to ensuring that: (i) Suitable markets are available for the processed timber; and (ii) The industrial climate is such that the plants can be operated so as to generate reasonable rates of return on investment. Markets 6.25 Up to the present time, all of the plywood and most of the sawn- wood produced in Indonesia is consumed domestically. According to projec- tions of the Department of Forestry, there is still considerable unsatisfied demand for these products in the country as shown below: Table 6.13 Projected Domestic Demand of Sawnwood and Plywood Item 1976 1980 Supply Demand Supply 1/ Demand (million cubic meters) Sawnwood 2.1 5.8 4.1 6.6 Plywood 0.24 0.28 0.7 0.31 1/ Supply in 1980 projected on basis of 70% utilization of projected capacity. 6.26 The demand figures for 1976 are based on expected figures of per- capital demand for sawnwood and plywood. Actual consumption was considerably lower and after allowing for exports, only about one-third of the reported domestic demand for sawnwood was met. This presumably reflects the inability of many Indonesians to finance timber purchases, making do with lower-cost traditional building materials. Prices of timber have risen sharply in re- cent months and it would seem inevitable that the actual domestic consumption of both plywood and sawnwcod will be considerably less than the theoretical demand for many years to come. Thus realistically, although projections suggest a shortage of sawnwood in the domestic market for 1980, there will almost certainly be potential for an exportable surplus of several million cubic meters. An exportable surplus of plywood is also expected, in this case amounting to several hundred thousand cubic meters. These figures are disturbingly imprecise but in the absence of more definitive information concerning capacity, operating ratios and domestic consumption, it is im- possible to pinpoint them with any greater accuracy. Nevertheless it is possible to briefly review the international markets for sawnwood and ply- wood of the types which would be produced in Indonesia and thereby assess the potential for marketing volumes of the magnitudes projected. 6.27 The Asian sawnwood trade is based on the logs of Indonesia, Malaysia and the Philippines. Statistics for 1974 based on the published data of FAO are as follows: - 12 - Table 6.14 Trade from Selected South-east Asian Sawnwood Producers, 1974 Importing Country Exporting Country or Region Malaysia Singapore Indonesia Philippines Total (thousand cubic meters) Asia - Japan 249 51 18 91 409 - Singapore 563 - 130 - 693 - Other 120 199 78 20 417 North America 164 68 5 74 311 Europe 636 210 85 41 972 Africa 62 175 5 - 242 Oceania 201 68 9 58 336 Total 1,995 771 330 284 3,380 6.28 These data suggest the following: (i) The total market for South-east Asian sawnwood is only about 3.4 million cubic meters annually. There would clearly have to be some significant structural changes if Indonesia is to effectively market "several" million cubic meters; and (ii) Japan, Singapore and Europe are the major markets for sawnwood from this region. 6.29 Similar statistics are available for plywood: Table 6.15 Trade in Asia Plywood, 1974 Importing Country Exporting Country or Region S. Korea China Philippines Singapore Malaysia Japan (thousand cubic meters) Japan 190 127 - 10 1 - Other Asia 16 104 24 95 106 16 North America 643 357 78 47 29 93 Europe 23 62 12 93 55 12 Other 4 35 4 44 8 2 Total 876 685 118 289 199 123 - 13 - 6.30 Indonesia exported a few thousand cubic meters of plywood in 1976 but if exports are to rise to the "several hundred thousand" cubic meters projected for 1980, the country will clearly become a significant factor in this market. 6.31 Because it is a major supplier of logs to the sawmill and plywood industries of Japan, China (Taiwan) and Korea, Indonesia has the power to gradually bring about the type of structural change in the markets which will substantially increase trade in these products while at the same time lessen- ing the trade in unprocEssed logs. There is little incentive in the coun- tries where processing is already undertaken to institute this type of struc- tural change and it will have to be brought about by the deliberate initia- tion of policies within Indonesia. Such policies have been adopted with some success in Malaysia and in the Philippines. In fact the extent to which these policies have only been partially successful must be attributed to the very great increase in log exports from Indonesia over the past several years. 6.32 To date there has been little work specifically aimed at presenting "Indonesian timber" effejctively in world markets. Much of the groundwork has already been accomp:lished in that the Indonesian species are virtually identical to those successfully marketed from Malaysia, Singapore and the Philippines. The major markets in Europe and Japan know these species and thus one of the major hurdles of marketing timber from a new supply source has been overcome. Product quality standards (the Malaysian Grading Rules) are accepted in world markets and an Indonesian version should further improve product marketability. Unfortunately, some of the early shipments of Indo- nesian timber did not meet specified quality standards and in some markets this has given the product a questionable reputation. To ensure that this situation does not deteriorate further and a healthy market is developed it is imperative that: (i) The industry adopt and conform .to a set of quality standards and grading rules; and (ii) Steps be taken to ensure that the mills have the equipmernt and the trained personnel to produce sawn- wood and, plywood which conform to these quality stan- dards. Financial and Economic Climate 6.33 The export of unprocessed logs from Indonesia over the past 6-7 years has, for the most part, been a very profitable activity. The pro- duction of sawnwood ancl plywood for sale in the domestic and export mar- kets has not. The reasons most frequently cited for this latter situation are: - 14 - (i) Capital costs are high in Indonesia because of: (a) the high cost of infrastructure associated with many of the developments; (b) rapidly escalating equipment prices; and (c) the high costs of importing equipment and materials into Indonesia due to high freight rates, and handling and other charges. (ii) Operating costs are high in Indonesia because of (a) the cost of operating and maintaining associated infrastructure; (b) the lack of skilled labor which adversely affects operating efficiency; and (c) the high cost of importing operating and maintenance supplies due to high freight rates and handling charges. 6.34 In the past 2-3 years, world prices for sawnwood and plywood have dropped sharply as a result of declining demand due to a slowing-down in construction, particularly residential construction in Japan and the United States. Indonesian producers with new high-cost plants are in competition with existing plants in other countries which were built at lower cost, and which now have highly trained operating crews. In the future prices may be expected to rise again but at the present time it is exceedingly diffi- cult for an Indonesia plant to compete in world markets with established plants in Malaysia, Japan, Korea and Taiwan. 6.35 This type of situation exists in many industries and in many countries but in this case, since many of the competing plants are using Indonesian logs, the means for a partial remedy is in the hands the Gov- ernment. Specifically if taxation policies were reviewed to provide more incentive for domestic processing and less incentive for log exports to potential competitors in other countries, the competitive situation could be improved. Conclusions 6.36 The policies of the Indonesian Government have been successful in bringing about the construction of substantial new sawnwood and plywood production capacity over a relatively short period of time. However, if this capacity and the substantial addition which are planned for the next few years is to be effectively utilized to bring about the desired effect of increasing value-added and employment in this industry in Indonesia, then certain positive steps will have to be undertaken by the industry and by Government. The critical problems which have been identified as im- peding progress towards these goals are: - 15 - (i) The lack of well-defined markets into which large volumes oi- Indonesian-produced sawnwood and ply- wood can move; and (ii) The lack of major financial incentive to shift from log exporits to domestic processing. 6.37 Under normal circumstances it might be expected that t:here would be considerable incentive from within the industry to overcome these prob- lems. However in Indonesia: (i) The organizations who have constructed and are opera- ting most of these plants are timber concession holders whose main business is exporting logs; (ii) In many cases the plants were constructed reluctantly by the concession holder, merely in order to allow him to continue extracting and exporting logs; and therefore (iii) Under these circumstances the normal motives for en- suring efficient operation of these plants are at least partially absent. 6.38 It is therefore imperative that the Government take steps to en- sure that the considerable investments in sawmilling and plywood machinery are effectively and economically utilized. The first step should undoubtedly be an in-depth survey of the problems of the industry leading to recommen- dations for solutions. On the basis of this preliminary overview, it has been concluded that such solutions might include: (i) The establishment of an effective export timber marketing board. This Board would initially be set up by the Government but financed through contribu- tions from industry to establish and monitor quality standards, and to develop markets and marketing chan- nels. The board would also establish links with major log importing organizations in order to assist in promoting an orderly phasing down of log exports in conjunction with a building up of processed wood exports into the same markets; (ii) The establishment of training and other technical fa- cilities designed to assist plants to produce sawn- wood and plywood to defined quality standards; and (iii) A review of taxing and pricing policies aimed at Giving the industry more incentive to produce sawn- wood and plywood domestically, and less incentive to export unprocessed logs. - 16 - VII. THE PULP AND PAPER INDUSTRY Introduction 7.01 Although the pulp and paper industry has obvious linkages to the timber industry, in the context of Indonesia the separate examination of these two subsectors is warranted because: (i) The timber resources which constitute the major part of Indonesia's large and profitable timber trade are not ne- cessarily those which would be most suitable for the domestic manufacture of pulp and paper; (ii) At the present time, most of the paper manufactured in the country is produced from non-wood fibers; and (iii) The development problems and prospects for the two sub- sectors are not the same. 7.02 The most significant feature of the Indonesia pulp and paper in- dustry is the slow development of domestic production leading to a very large dependence on imports, despite the availability of a wide variety of fibers suitable for paper-making. Only 20% of the country's requirement for paper and paperboard is produced domestically, and much of this production is from imported pulp. In 1975, even though world prices were significantly depressed, imports of pulp, paper and paper products were valued at over US$70 million. 7.03 This chapter examines the history, present status and future prospects of the pulp and paper industry in Indonesia, giving particular emphasis to the factors which have constrained its development in the past, and to identifying programs and specific projects which could enhance its development in the future. Structure of the Industry Imports 7.04 Because 80% of Indonesia's paper requirements are imported, it is logical to begin any examination of the structure of the industry with a brief review of the paper importing business. In 1975, the volume of im- ports by principal grade and origin were as shown in the following table. - 17 - Table 7.1 Pattern of Paper Imports (1975) 1/ Grade Group Amount by Origin Japan Other Asia N.America Europe Other Total (thousands of tons) Newsprint 14.1 3.3 16.0 9.2 4.1 46.7 Printing & Writing 19.0 5.5 7.2 3.5 0.1 35.3 Packaging Paper & Board 16.9 19.7 13.5 9.2 7.5 66.8 Speciality Papers 4.7 2.1 1.4 4.7 - 12.9 Paper Products 2.5 3.1 1.0 0.8 0.4 7.8 Total 57.2 33.7 39.1 27.4 12.1 169.5 1/ Foreign Trade Statistics of Indonesia 7.05 Although Japan is the largest single supplier country, it by no means dominates the supply picture. Substantial volumes of newsprint, for example, are imported from Canada, New Zealand, Norway and Fin:Land. Kraft sack paper and linerboard are shipped primarily from the United States. Other important suppliers of various grades include China, Taiwan, Singapore, Sweden and France. The large number of suppliers make this market (and others in Southeast Asia) very competitive with few long-term contracts between the producer and the Indonesian importer or agent. Prices vary considerably, often being lower than the world prices between major trading partners during periods of over-supply, and very much higher when paper is in short-supply. The region is known as a "dumping ground" for major producers where neither formal nor informal price agreements are observed. 7.06 Imports of paper are important not only as the major source of paper supply, but also because the import price is the major determinant of the prices obtained by local producers. Most domestic production is in the print- ing and writing grades and the prices of competing domestic and imported supplies of these grades, after adjustment for all duties, taxes, and other charges, are generally within 5% of one another. Thus the variability of the prices of imported paper provides an element of instability in the domestic producers' market which is, however, partly offset by the system of check- pricing 1/ used to assess import duties. Existing Domestic Capacity 7.07 At the present time there are 8 paper plants in operation in the country. In total these plants employ about 6,000 people. The current value 1/ Check-pricing is a system whereby prices are set by the Government for the purposes of computing import and export taxes. This removes the major incentive for under-invoicing to minimize these taxes. - 18 - of the assets of the industry is not known but to replace the existing capa- city at today's prices would require an investment of the order of $150 million. The existing mills are as follows: Table 7.2 Operating Pulp and Paper Plants in Indonesia Plant and Ownership Year Started Capacity 1975 Production (tons/annum) Government-Owned - Padalarang 1923 4,900 4,700 1/ - Lejes 1940 14,000 13,800 - Blabak 1961 7,200 6,500 - Basuki Rachmat 1969 14,000 10,000 - Gowa 1967 15,000 10,900 Privately-Owned: - Surya Kertas 1975 9,000 - 2/ - Delta Paper Mill 1975 1,200 - 2/ - Inpama 1975 1,500 - 2/ Total 66,800 45,900 1/ Estimated 2/ These mills commenced operation in 1975; their production in that year is not known. 7.08 The Basuki Rachmat and Gowa mills have recently expanded, but the expansions were not fully operational in 1975. Otherwise, all of the Government-owned mills which are operating are running at close to full capacity. Most of this capacity is for printing and writing grades al- though cigarette paper, tissue, and some light boards are also produced. Two other mills are owned by the Government but are not now operating. The Pematang Siantar mill in North Sumatra was designed to produce 5,000 tons of newsprint annually and operations first commenced in 1962. It was closed down in 1965 but operated again in the late 1960's and early 1970's at very low production rates. In 1975, the paper machine from this mill was dis- mantled and shipped to Gowa where it formed the nucleus of that mill's ex- pansion. The other mill which is not in operation is the Martapura mill located near Bandjarmasin in South Kalimantan. Construction of this mill commenced in 1959 and the first commercial operation was in 1972. At the present time, however, it is shut down and it is not clear whether it will ever be started up again. Brief descriptions of the operating mills are contained in the following paragraphs. 7.09 The Padalarang mill located near Bandung in West Java is the oldest in the country. Operations commenced in 1923 and were expanded - 19 - in 1938 with the addition. of a second paper machine. A third paper ma- chine to produce cigarette paper was added recently. The mill now pro- duces up to 5,000 tons annually of printing, writing, cigarette and wrap- ping papers from rice-straw pulp made at the mill, supplemented with pur- chased pulp and waste paper. With the exception of the new paper machine, most of the equipment in the plant is obsolete and not in very good condi- tion. Thus, although operations are as efficient as equipment limitations allow, chemical costs are high and paper quality off the older paper ma- chines is low. The mill is reported to be modestly profitable but only as a consequence of the highly protected domestic market. The mill is lo- cated in a major rice growing region and there is apparently adequate rice straw over and above existing requirements to supply an expanded operation. However, no expansion is planned. 7.10 The Lejes mill in East Java is the country's largest and is cur- rently expanding to a capacity of 24,000 tons through a program of pulp- mill expansion and paper machine modernization. This program is being financed indirectly by the Bank through Bapindo, the Development Bank of Indonesia. The mill produces printing and writing papers on two paper ma- chines, from bleached rice-straw pulp manufactured at the mill, supplemented with purchased long-fibered pulp and waste paper. As part of the current expansion plan, a chlorine and caustic plant is being installed. The mill has generated profits in each year since 1972 when domestic paper prices rose sharply through the imposition of higher duties on imports. The cur- rent expansion should improve the financial position of the mill. as sub- stantial increases in production will be achieved for a relatively modest investment. The Lejes mill has tentative plans for further expansion by the addition of a new puLping line and a new paper machine with a capa- city of 45,000 tons annually. There is insufficient rice straw in the re- gion to support an expansion of this magnitude and the company proposes to use bagasse. 7.11 The Blabak mill in Central Java has the capacity to produce 7,200 tons of printing and writing papers annually using bleached rice-straw pulp manufactured at the mill together with purchased long-fibered pulp. The mill was built in the late 1950's, partially financed through Italian aid, and was later owned and operated by Bapindo. Like the four other Government- owned mills it is now run as an independent corporation under the supervision of the Directorate General of Chemical Industries. The mill was built to use the Italian two-stage Poinilio pulping process but this has been modified to a conventional soda cook, similar to that utilized in the Padalarang and Lejes mills. There is apparently ample excess rice-straw in the region and the mill is proposing an expansion of some 14,000 tons annually. Applica- tion has been made to Bapindo for assistance in financing this project. At the present time, the mill is reported to be barely profitable. 7.12 The Basuki Rachmat mill near Banjuwangi in East Java produces printing and writing papers from bleached sulphate bamboo and pine pulp. The mill was supplied under a Japanese reparation scheme and includes a chemical recovery system. With the assistance of a loan from Bapindo the - 20 - mill has recently been optimized and effective capacity increased from 9,000 to 14,000 tons annually. An electrolytic plant for producing chlorine and caustic soda was included in this project. The mill was originally de- signed to utilize solely bamboo as raw material but harvesting and operating problems in the early years led to the establishment of plantations of Pinus merkusii. The mill began using pine several years ago, apparently success- fully. At the expanded production level, this mill is expected to be mod- erately profitable. 7.13 The Gowa paper mill near Ujung Padang in South Sulawesi was de- signed and built along with the Basuki Rachmat mill as part of a Japanese reparation scheme. The mills are similar in design and concept. The Gowa mill has recently expanded production from the original 9,000 tons annually to 15,000 tons, by adding the rebuilt machine taken from the now defunct Pematang Siantar mill. A coating line for printing and writing paper pro- duction was added at the same time, and this expansion, financed in part by Bapindo, is now in commercial operation. This mill is operated efficiently within the limitation of the available equipment. Gowa's paper is consi- dered to be among the best of the domestically produced grades and the com- pany generates modest profits. To decrease the problems associated with using bamboo as a raw materials, the company is also utilizing locally ob- tained mangrove. In addition, plantations of pine and eucalyptus are being established and in the long term, an expansion based on these raw materials is contemplated. 7.14 None of the three newly constructed private mills includes an in- tegrated pulping facility and all use imported pulp. The Impama mill in Jakarta is designed to produce 1,500 tons per annum of tissue and in this case the pulp furnish is supplemented with waste paper. The Surya Kertas mill in Central Java will produce 9,000 tons of printing and writing paper. The Delta paper mill in North Sumatra will produce 1,200 tons of cigarette paper annually. Current Development Activity 7.15 The Directorate of Chemical Industries reports that nine new mills, all in the private sector, are presently under construction in Indonesia, and licenses have been granted to a number of others. Key features of those mills reported to be actually under construction are summarized in the following table. - 21 - Table 7.3 New Pulp and/or Paper Mills Under Construction in Indonesia Capacity Type 1/ Start-up Estimated (tons/A) Date Capital ($ million) West Java - Bekasi Tegush 12,000 (d) 1977 n.a. - Pindodeli 9,000 (a) 1977 4.5 - Unipa Daya 18,000 (a) 1977 5.0 - Karya Tulada 4,000 (c) n.a. n.a. - Papyrus Sakti 4,000 (c) 1977 1.0 East Java - Tjiwi Kimia 12,000 (a) 1977 6.0 - Sarawati Bhakti 14,000 (a) 1977 9.5 - Pakerin 24,000 (b) n.a. n.a. - Eureka Abad. 12,000 (d) n.a n.a. 1/ Type Key: (a) printing & writing, imported pulp (b) printing & writing, pulping included (c) other grades, imported pulp (d) other grades, pulping included 7.16 If completed on schedule, this program will bring the installed paper production capacii:y in Indonesia to a total of 176,000 tons annually (equivalent to above 160,000 tons of effective capacity), of which approxi- mately 110,000 tons would be in printing and writing grades. By 1980, the total demand for paper is expected to reach approximately 410,000 tons, so that substantial imports would still be required in all grades except printing and writing paper. Moreover, because much of the new capacity would use purchased pulp, imports of pulp would increase from a present level of 20,000 tons to about 70,000 toiis annually. Although current development activity is impressive in terms of the number of projects, these are on a very small scale and in view of the grow:ing demand, they will not materially reduce the country's reliance on imports. Technology 7.17 The existing industrial plants, and those under construction, can be grouped in three categories according to the level of technology employed. (i) Non-intepgrated Paper Mills: These are the simplest mills, comprising one or more paper machines with a stock preaparation system and associated service plants. Fiber fu:cnish for the paper machine, consisting of pulp and sometimes waste paper, is purchased externally. The three existing privately-owned mills, and six of the nine milLs under construction are of this type. - 22 - (ii) Integrated Pulp and Paper Mills without Chemical Recovery: Three of the Government mills (Padalarang, Lejes and Blabak), and three of the mills under con- struction are of this type. All are pulping rice straw by the soda process and the spent liquor after cooking is simply discharged from the mill as effluent. Chemical recovery processes are technically feasible for these plants but they would be complicated by the high levels of silica in the rice straw, and would be of doubtful economic worth in view of the small plant sizes. (iii) Integrated Pulp and Paper Mills with Chemical Recovery: The Basuki Rachmat and Gowa Mills are fully integrated sulphate pulp mills with chemical recovery sytems. In basic process design they are therefore similar to mo- dern pulp and paper mills throughout the world. How- ever, their design production capacity is perhaps one- fifth of what might be considered the minimum economic size for this type of plant and, as discussed below, the costs of production are therefore excessively high. 7.18 Basic processes in the pulp and paper industry have not changed substantially over the past 20 years although many technological improve- ments have led to improved yields, better product quality and lower pro- duction costs. Most of the equipment in use in Indonesian mills is thus similar in concept to the large, modern equipment constructed today and can, at least in principle, produce similar grades of paper. The newer mills in Indonesia are still very small by modern standards, and in order to keep their capital costs low the designers have patterned their equip- ment along the lines of that in the older mills. Again, these mills are capable of producing good quality paper but operating costs are high be- cause: (i) The equipment is smaller and slower and has some costs which are more-or-less fixed per piece of equipment (labor and some overheads, for example), making them much higher on a per ton of paper product basis; (ii) Modern mills incorporate extensive facilities for the recovery and re-use of fiber and chemi- cals whereas older mills (or very small mills using old designs) do not; (iii) Older mills are less efficient in terms of their utilization of heat and power; and - 23 - (iv) Older mills incorporate less sophisticated quality control features and the varying quality of paper leads to losses in the finishing operations. In Indonesia's oldest mill, Padalarang, these losses range up) to 25% of the production off the paper machine; in the newer mills, 10-15 seems to be normal. 7.19 By patterning their equipment on the older designs, the engineers responsible for specifying equipment in the newer Indonesian mills appear to be able to keep investrment costs per ton of production capacity comparable to those which might be expected for much larger plants and thus minimize the dis-economies of small--scale construction. However, operating costs are substantially higher for the technological reasons noted above, and also because Indonesia (in common with many developing countries) is forced to pay higher prices for many chemicals and other imported raw materials due to high transportation costs and surcharges on the relatively small vclumes involved. Although there are so maany variations from plant to plant that. these factors are difficult to quant:ify, the following table has been prepared to show the approximate differences between operating costs in the existing Indonesian industry, and in an economically-sized plant in an industrialized country. Table 7.4 Comparative Production Costs - Indonesia and an Economic-Sized Plant in an Industrialized Region Item _Tvical Costs Difference due to: Indonesia Comparison 1/ Technology P'rices Total (US$/ton) (US$/'ton) Fiber 115 80 25 10 35 Chemicals 105 60 15 30 45 Other Supplies 90 55 20 15 35 Fuel, Power 80 60 20 0 20 Maintenance 50 20 25 5 30 Labor 70 70 *2/ * 2/ 0 Overhead 110 25 85 0 85 Depreciation 40 40 - 0 0 Total 660 410 190 60 250 1/ A hypothetical plant about 5 years old, producing 100,000 tons per annum of printing and writing papers in a location where chemicals and other supplies are avaiLable at competitive prices. 2/ Direct wages in Indonesia are about one-tenth the levels in a "typical industrialized-coiantry paper mill". However, the mills are so small that about ten times as much labor per unit of output is employed. Thus the potential advantages of relatively low wage rates in Indonesia is lost. - 24 - It can be seen that the existing Indonesian pulp and paper mills suffer a basic cost disadvantage due to equipment size, the lack of equipment sophistication, and their location. No matter how efficiently these plants may be operated, they suffer a substantial cost disadvantage by comparison with economically sized plants in other regions. Most of the plants now under construction in the country will suffer a similar disadvantage. Profitability 7.20 Recent production and operating cost data were examined for four of the Government-owned mills and using this data, an approximate overall profit-and-loss statement for the existing pulp and paper industry has been developed. The following table shows the results of this analysis on a "per ton of paper" basis. The table also illustrates how the CIF cost of imported paper sets the price for the domestic industry. Table 7.5 Economics of Pulp and Paper Production in Indonesia 1/ Item Amount (US$/ton) Imported Paper CIF Cost 460 Duty 280 Handling and Other Changes 80 360 Prices ex-warehouse 820 Domestic Production Price ex-warehouse 820 Discounts 2/ 20 Freight & Handling 50 Commission, etc. 3/ 30 100 Mill Net Sales Revenue 720 Production Costs Fiber 115 Chemicals 105 Other Supplies 90 Fuel, Power 80 Maintenance 50 Labor 70 Overhead 110 Depreciation 40 660 4/ Total Profit Before Taxes 60 1/ Based on average data -from operating mills. 2/ These discounts are probably given to volume customers, or for prompt payment. 3/ Commissions are paid to sales agents in the main consuming centers. 4/ Of which about US$300/ton is foreign exchange. - 25 - 7.21 These data show quite clearly that: (i) Direct operating costs exceed by a wide margin the cost of importing paper; (ii) The profit margin of the domestic industry is subst:antially less than the duty applied to imported paper; and (iii) The profit margin is extremely sensitive to the CIF cost of imported paper; a reduction in the import price of less than 10% would eliminate the profits of the Indonesian industry. Development Potential in the Industry 7.22 Despite the fact that three of the five Government-.owned mills have recently completed expansion programs, three new privately-owned mills have just commenced operation, and nine more mills are currently under con- struction, Indonesia :Lmports more paper now than in 1970 and, unless a timely start is made on some of the large projects which have been proposed but not yet started, import requirements will be substantially more by 1980. This situation is illustrai:ed in the following Table which shows demand and capacity for 1970 and 1975, wit:h a projection to 1980. Table 7.6 Past:, Present and Projected Future I/ Supply and Demand Balance Plants in Effective Total Approximate Operation Capacity 2/ Demand Supply Gap Import Value 4/ (No.) (tons/A) (tons/A) (tons/A) ($/A) 1970 5 24,000 140,000 116,000 60,000,000 1975 8 60,000 230,000 170,000 85,000,000 1980 17 160,000 410,000 3/ 250,000 120,000,000 1/ Considering only those plants actually under construction. 2/ Calculated as 90,' of reported rated capacity. 3/ For details of this demand projection and projections to 1985, see Annex 7-1. 4/ At 1977 prices. 7.23 Because it takes from 3-4 years to plan, design and build a major pulp and paper plant it is unlikely that the situation in 1980 will be substan- tially different from that projected above. After 1980, development could follow a number of alt:ernative routes including: - 26 - (i) A halt in the construction of new capacity, with increased reliance on imports; (ii) The continuation of the present practice of constructing and expanding small units primarily using imported pulp or agricultural residues; or (iii) The construction of one or more relatively large units to supply both pulp and paper to the domestic market. The Government's present policy is to attempt to promote development in the private sector. Licenses have been given for the con- struction of large and small mills but, up to the present time, only small mills have been built and, as illustrated above, the supply gap is widening. In implementation, therefore, development strategy lies somewhere between alternatives '(i)' and '(ii)' above. Annex 7-1 contains a preliminary comparative analysis of the costs and benefits associated with each of these strategies. 1/ The following table shows the results of this comparison. 1/ Annex 7-1 "Development Potential in the Pulp and Paper Sector" presents details of the strategies examined, analyses of the fiber resources of Indonesia as they related to the potential for pulp and paper production, and reviews of the domestic and export markets in this sector. - 27 - Table 7.7 Comparison of Alternative Development Strategies In the Pulp and Paper Subsector Item Strategy 1 Strategy 2 Strategy 3 Brief Description No New Mill Continue Small Large and Medium Construction Mill Construction Mill Construction Domestic Supply (thousand. tons) 1980 (Demand: 410) 146 146 146 1985 (Demand: 600) 160 210 446 1990 (Demand: 880) 160 320 650 Self-Sufficiency (percent) 1980 36% 36% 36% 1985 27% 35% 74% 1990 18% 36% 74% Projected Cost of Pulp and Paper Imports in 1990 ($ million) 410 370 140 Investment Program 1978 - 1990 ($ million) 0 290 1,200 Employment Created (jobs) 0 10,000 10,000 Cost of Employment Creatjion ($/job) - 29,000 120,000 Return on Investment 1/ (percent) Financial 6% 17% Economic - negative 11% Cost of Strategy 1978 - 2000 ($ million) Imports 10,100 9,360 5,550 Production Cost 1,300 2,050 3,550 Capital 0 290 1,200 Total 11,400 11,700 10,300 of Which Foreign Excchange 10,600 10,400 7,700 Net Benefit 2/ of Strategy, Using Economic Prices, Discounted to Present Value at 10% ($ million) At Current Paper Prices 0 (180) 70 At prices up by 20% 0 (140) 380 At prices down by 20% 0 (230) (270) 1/ Financial returns estimated using current 60% duty protection on most grades. Economic return based on international prices but foreign exchange and labor shadow prices estimated at 125% and 50% of current market values. 2/ The "benefit" of Strategies 2 and 3 has been taken to be the differential net present value b't comparison with Strategy 1. Thus the net benefit of Strategy 1 is by definition, zero. - 28 - 7.24 The above results, although based on data assumptions which must be considered approximate, allow the following conclusions to be drawn. (i) By 1990, imports of paper could cost Indonesia between US$140 million and US$400 million annually (in 1977 prices) depending on the development strategy adopted for the pulp and paper industry; (ii) The present strategy of small mill construction is inefficient and expensive. It generates a low rate of financial return, a negative rate of economic return, and irrespective of paper price assumptions over a wide range, it is consistently the highest cost solution to Indonesia's paper supply problem; and (iii) A program of large mill construction considered overall is not outstandingly attractive in terms of financial or economic rate of return but it would substantially reduce the foreign exchange cost of supplying paper. If the paper prices used in the analysis are reasonably represen- tative of the real price level (in relation to production costs and capital costs) then building large pulp and paper mills generates an economic rate of return slightly better than 10% and the incremental net present value of this strategy (at a 10% discount rate) is $70 million. If paper prices increase in relation to other costs, how- ever, then the construction of large mills becomes a much more attractive alternative. 7.25 The generally low rates of return which are projected for any investment in Indonesia's paper industry are typical of the results obtained at the present time when evaluating investments in this industry in most areas of the world. The costs of building and operating pulp and paper mills have increased more rapidly than product prices and at the same time the demand for paper has slumped as a result of the world economic slowdown. Present price levels are not sufficiently high to warrant construction of new capacity and as demand begins to pick up, a supply shortage in the medium term future, leading to price increases, appears inevitable. Project Analysis 7.26 The tentative program of large mill construction evaluated in the preceding analysis included: four medium-sized, partially integrated mills to produce printing, writing and packaging grades; a chemical pulp mill; a kraft paper and board mill; and a newsprint mill. The overall profitability of this program was shown to be marginal, by comparison with importing paper, but would become more attractive if world paper prices increases. If a program of large mill construction is to be embarked upon, it is evident that some ranking of the projects within such a program should be undertaken in order that priorities can be assigned. - 29 - 7.27 At least six mills which would fit into such a program have been proposed as projects in Indonesia. In some cases foreign partners have been found, the necessary licenses obtained, and timber concession agreements reached. Nevertheless, at the present time not one of these projects is being implemented and there has been no notable progress towards implementation in the past 1-2 years. Reasons for this include: (i) The high cost of the infrastructure which would be required for some of the projects; (ii) The large amount of investment capital required, which in some cases may be beyond the resources of the present sponsors to mobilize; and (iii) The rather modest projections of profitability of the previous projects. 7.28 In order to analyze these projects more closely, updated estimates of costs and benefits have been developed and are presented in Annex 7-1. The projects have been reviewed more or less as proposed although in some cases the capacity and product, line were modififed to better suit the projected domestic market. The projects are listed below. It should be noted that some of them would be complementary in supplying the domestic market in Indonesia whereas others would be competing for the same market. (i) Aceh: an unbleached kraft paper and board mill which at full capacity would produce 170,000 tons per annum of sack kraft paper, linerboard, and other kraft paper for the domestic market. (ii) South Sumatra: a bleached kraft pulp and paper mill which at full capacity would produce 80,000 tons per annum of printing and writing paper, and 100,000 tons per annum of pulp, all for the domestic market. (iii) Central Java: a newsprint mill which at full capacity would produce 160,000 tons of newsprint for the domestic market. The 24,000 tons of chemical pulp required for this production would be manufactured elsewhere. (iv) East Java: a bagasse-line addition to the Lejes mill to produce 45,000 tons of printing and writing paper for the domestic market. (v) South Central Kalimantan: a 200,000 ton per annum long and short fibered bleached kraft pulp mill. By 1990, as much as 140,000 tons of this product could be sold in Indonesia, the balance would have to be exported. - 30 - (vi) East Kalimantan: a 200,000 ton per annum short-fibered bleached kraft pulp mill. By 1990, approximately 70,000 tons of this product could be sold in Indonesia, the balance would have to be exported. 7.29 The following table summarizes the key features and the results of preliminary financial and economic analyses for each of the six projects examined. The financial rates of return were estimated using 60% duty on all paper grades except newsprint, where a 10% duty was applied. No duty was applied to pulp prices. The economic rates of return were estimated using international prices except that unskilled labor and foreign exchange were respectively shadow-priced at 60% and 125% of current market prices. Table 7-8 Comparison of Potential Pulp and Paper Projects Project 1 2 3 4 5 6 Location South Central East South/Central East Aceh Sumatera Java Java Kalimantan Kalimantan (US$ million) Production (thousand tons) - Kraft Paper and Board 170 - - Printing and Writing - 80 - 45 - - - Bleached Pulp - 100 - - 200 200 - Newsprint - - 160 - Exports - Bleached Pulp - - - - 60 130 Capital Cost ($ million>$ 410 375 225 140 350 350 Employment Created (jobs) 3,200 3,200 2,000 1,000 1,600 1,600 Cost of Employment Creation ($/Job) 128,000 117,000 112,000 140,000 187,000 187,000 Return on Investment - Financial (%) 17 15 10 9 10 9 - Economic (%) 10 12 12 7 14 13 Factor by which costs or benefits mus+t ^ 4lt±4plid to obtai.n a '15% Economic Rate of Return - Paper Prices 1.27 1.13 1.09 1.36 1.06 1.10 - Capital Costs 0.72 0.83 0.85 0.57 0.90 o.86 - Production Costs 0.12 0.63 0.82 0.24 0.83 0.71 - 32 - Discussion 7.30 The data contained in the preceding table is of a preliminary nature, and based on tentative estimates of markets, prices, and capital costs. Nevertheless, comparison with other projects for which detailed analyses have been undertaken shows the results to be of the right order. The results lead to the following conclusions: (i) The two projects which show a reasonably attractive financial rate of return (Aceh and South Sumatra) are those which would be selling in the domestic market with 60% duty protection; (ii) The two projects which show a reasonably attractive economic rate of return (the pulp export projects on Kalimantan) would be selling significant tonnage into rather uncertain inter- national markets. Moreover a significant part of the return is derived from the 125% valuation of foreign exchange which may or may not be realistic. Without this adjustment, the economic rates of return for these two projects would drop by 2-3 percentage points. (iii) All projects are quite sensitive to market price changes, and less sensitive to changes in capital costs or production costs; and (iv) As might be expected, the larger mills generate the highest rate of return. 7.31 None of the projects stands out as being particularly attractive in financial and economic terms. Nevertheless, all would provide the country with needed supplies of pulp and paper and provide insulation against fluctua- tions in world supply and prices; all would contribute to the transfer of technology to Indonesia; all would generate attendant benefits in associated industries such as paper converting, construction, engineering, transportation and chemicals; and with the exception of the two projects in Java, all would have a substantial development effect in regions which are presently under- populated and underindustrialized. Moreover, relatively modest increases in world prices would raise the rate of return for several of these projects to acceptable levels. Given the small amount of new capacity which is being installed worldwide, and the expected steady increases in the demand for paper and paperboard, such prices increases would appear to be inevitable if capital for new capacity is to be attracted back to the industry. 7.32 The main conclusions which can be drawn from the analysis of develop- ment prospects presented in Annex 7-1 and summarized in the preceeding para- graphs are: (i) Indonesia has the fiber resources for a wide range of pulp and paper projects. Of particular value are the long-fibered resources (both natural and planted) which are rare in Asia; and - 33 - (ii) The domestic market in Indonesia is large enough to provide immediate opportunities for large-scale development producing a variety of products. The export market for long-fibered grades is also attractive, and could provide a temporary outlet for excess production from large-scale plants. Conclusions 7.33 The main conclusions which can be drawn from the material contained in this Chapter are: (i) The Indonesian pulp and paper industry has been slow to develop with the result that the country now imports over 80% of its paper requirements. No other country in the world with suitable fiber resources is so dependent on imports; (ii) Development of the industry now as in the past is confined to the construction and expansion of very small production units. Although these mills appear to be quite efficiently operated, they could never be profitable if not protected from import competition by a 60% tariff barrier; (iii) The protective tariff not only allows the existing industry to keep operating but is also attracting new private capital. New plants are also very small and this strategy is seen to be yielding a negative economic rate of return; and (iv) Large plants have been proposed for various locations in the country which would materially improve the domestic supply solution. At current world paper prices these projects are only marginally attractive but rates of return would improve substantially with the higher prices which are projected. 7.34 Indonesia has many development options and the pulp and paper sector is only one of them. :t is hoped that the material contained herein will be of assistance to the Government in determining: (i) What priorities should be given to promoting development of this sector in relation to others; and (ii) What projects (or types of project) should be considered of highest priority within the sector. - 34 - Recommendations 7.35 If development of the pulp and paper sector is given priority by the Government, there are a number of steps which should be taken to facilitate the implementation of projects which would provide an economic benefit to the country. Recent experience shows that leaving such development to the private sector is not an effective way to secure the desired results, primarily because of the high investment costs of an economic-sized plant, the high costs of related infrastructure, and the relatively marginal rates of financial return. Under these circumstances, a number of alternative development strategies could be considered but the one that appears to have the best chance of being effective would be for the Government to: (i) Form a public sector pulp and paper company which would take over control of the five existing government-owned pulp and paper mills. The company could be staffed with people from the mills and from the Cellulose Industries Division of the Department of Chemical Industries; (ii) Empower this company to engage consultants as necessary, and to negotiate with the sponsors of the five or six major pulp and paper projects under consideration in the country; (iii) Select the best project for immediate development and form a partnership with the existing sponsor if this is deemed appropriate; (iv) Contract for a bankable feasibility study to secure loan finance for the project. Raise equity through a combination of government grant, funds generated by the existing plants, and contributions from any private partners; and (v) Proceed to implement the project and commence evaluating a second project. - 35 - INDONESIA INDUSTRIAL MISSION ANNEX TO CHAPTER VII DEVELOPMENT POTENTIAL IN THE PULP AND PAPER SECTOR A. Introduction 1. At the present time, capacity in the Indonesian pulp and paper subsector is limited to a number of relatively small production units and although plans have been announced for the construction of some large plants, none of these appear to be sufficiently far advanced to have any impact on the projected supply gap before 1980. In that year, projections suggest that although 17 plants will be in operation with a combined annual capacity of 160,000 tons, (compared with 8 plants and 60,000 tons capacity at present), paper and paperboard imports will have risen from a current level of 170,000 tons to 250,000 tons annually. Moreover much of the new capacity will use imported pulp causing pulp imports to increase from 20,000 to 70,000 tons. 2. By 1980, the country will be producing most of its requirements for printing and writing papers and for some packaging grades. However, large quantities of newsprint, kraft packaging grades and pulp will still have to be imported. The most efficient way to avoid these imports would be to construct large plants using wood as a raw material. Projects of this type have been identified but progress towards their implementation has been slow. This Annex supports and expands the material contained in Chapter VII dealing with the pot:ential for development of the pulp and paper sector in Indonesia. It begins wi.th an examination of the fiber resource base and a review of the domestic and export market potential. The alternative sectorial development strategies and potential project opportunities compared in the Chapter are then described. B. Fiber Resources 3. Indonesia's forest and non-wood fiber resources suitable for pulp and paper manufacture have been examined in a number of studies undertaken by the Bank and others during the past five years. 1/ No detailed coverage 1/ IBRD; Agricultural Sector Summary, 1972. IBRD; Planning for Industrial Development in Indonesia, 1972. FAO; Forest Resources in the Asia and Far East Region, 1976. CIDA; National Pulp and Paper Survey, 1972. University of Gadjah Mada, Indonesia; Foreign Investment in the Forest Based Sector of Indonesia, 1975. Government of Indonesia; Sumatra Regional Planning Study, 1976. - 36 - of this material is presented here because the quantity and diversity of the available resources, together with the potential for the development of industrial forest plantations, are substantial enough to allow the establish- ment of almost any conceivable pulp and paper industry. The following para- graphs therefore merely summarize the significant factors concerning each major type of fiber resource. Natural Forest Resources 4. About 120 million hectares, or over 60% of Indonesia's total land area, is classed as forest land. This is the largest forest resource in Asia and one of the largest in the world. The geographical distribution of forest land is approximately as follows: Distribution of Forest Land Total Land Forest Land Location Area Area -----(million hectares)------ Sumatra 47 28 Kalimantan 54 41 Sulawesi 19 10 Maluku 8 6 West Irian 42 32 Java, Madura 13 3 Bali, Nusa Tenggara 7 2 190 122 Source: Central Bureau of Statistics. Other sources suggest Indonesia's total land area is as much as 202.7 million hectares. 5. The total growing stock of timber in excess of 50 cm diameter on land for which concessions have already been granted 1/ has been estimated by the Directorate General of Forestry to be about 3,200 million cubic meters. An approximate breakdown by region and major species group has been prepared from a variety of sources as follows: 1/ Based on 1974 data when 385 concessions covering about 33 million hectares had been granted. - 37 - Distribution of Growing Stock Location Volume Dipterocarp Ramin Agathis Pine Other Total ---------------(million cubic meters)---------------- Sumatra 394 1 - 21 344 760 Kalimantan 1,166 74 6 - 834 2,080 Sulawesi 3 - 2 - 175 180 Maluku 77 - 1 - 62 140 West Irian - - - - 40 40 Java, Madura - - - 8 n.a. n.a. Bali, Nusa Tenggara - - _ 1,640 75 9 29 1,455 3,200 6. The figures are approximate but they indicate that more than one- half of the standing wood volume in Indonesia is in the dipterocarp species family whereas most of the remainder, designated "other", is made up of a large number of mixed, tropical hardwood species. The figures also show that almost 90% of the country's surveyed timber resources are in Sumatra and Kalimantan. 7. The use of dipterocarps and mixed hardwood species for manufacturing pulp and paper is a reasonably well established practice. A mill in the Philippines is producing newsprint and packaging paperboard using a large per- centage of dipterocarp species, and for several years Japanese pulp and paper producers have been impiorting chipped wood from southeast Asia. Nevertheless it must be recognized that these woods are not preferred species for paper- making, primarily because of their short fibers (which do not provide much of the strength necessary in many grades), their dark color, and the lack of uniformity which results from an uncontrollable mix of species. The mill in the Philippines is overcoming these problems by switching to fast-growing plantation species as qjuickly as they become available, and in the meantime by doing some sorting of the tropical hardwood finish. The Japanese mills are confining their usage of these woods to a limited number of grades where their shortcomings are of relatively minor importance, and to minor propor- tions of the total fiber furnish. In both countries the paper products manufactured from dipterocarps and mixed tropical hardwoods are consumed domestically and do not: face international competition in world markets. Thus, although there are a number of countries which, like Indonesia, have large resources of tropical hardwoods, generally believed to be suitable for producing pulp and paper, there has been relatively little activity in this area, particularly if t:he product is to be sold in international markets. Instead many countries are establishing plantations of fast-growing eucalyptus and other hardwood species which can generally be grown and harvested at costs comparable to or cheaper than those which would be encountered when logging a natural tropical forest. - 38 - 8. Despite these reservations, it would certainly be possible to estab- lish a project using indigenous Indonesian hardwoods, and several such projects, particularly in Kalimantan, have been proposed. However in considering any such project, certain factors should be kept in mind: (i) The project would benefit by having as much as possible of its market within Indonesia, to avoid the problems of entering international markets with an unknown product; (ii) To the extent that the project would sell in international markets, price discounts should be anticipated; and (iii) Any such project should be carefully compared with a planta- tion pulpwood alternative which would not face the same marketing problems. 9. In addition to the very large quantities of dipterocarps and other mixed hardwoods, there are also substantial amounts of ramin, agathis and pine in various parts of the country. Ramin has been tested and found to be quite suitable for the manufacture of certain grades of paper but its occurrence in the natural forest is rather scattered. Thus, although there are an estimated 70 million cubic meters or more of ramin in Kalimantan, it could not be economically harvested as a single species. Agathis and pine, on the other hand occur in relatively consolidated areas. The natural pinus kerkusii forest of northern Sumatra is the basis for one project under consideration, and the relatively large areas of agathis which are reported to occur with dipterocarps and ramin in Central and South Kalimantan are being considered for another. In Central Java, plantations of pine and agathis are said to be large enough to provide the fiber resource for a large paper mill producing newsprint or other grades of paper. 10. The close attention by the pulp and paper sector to the available stands of natural and planted pine and agathis is technologically very sound. These species possess the valuable characteristics of having a relatively long fiber enabling them to be used in many grades of paper and paperboard where short fibers would be less desirable or, in some cases, just not suit- able. Specific examples of such grades are newsprint and kraft paper and board, which together account for over 40% of Indonesia's total paper and paperboard consumption. In addition most other grades benefit from the addition of some proportion of long-fibered pulp. Moreover, all of Asia is deficit in long-fibered pulpwood resources and although plantations are being established in a number of countries, the region will be a net importer for many years to come. Thus, from the point of view of both domestic markets and regional export potential, the long-fibered pine and agathis resources of Indonesia are the country's most valuable raw material for pulp and paper manuf ectuire. - 39 - Agricultural Residues 11. Agricultural residues used for pulp and paper manufact:ure include straw from rice and various grains, bagasse from sugarcane, and cotton linters. In Indonesia, rice straw has been the most important cdomestic fibrous raw material for pulping and is used in the Lejes, Padalarang and Blabak mills. In addition, several of the mills now under const:ruction will use rice straw. Bagasse is not used at present but a major expansion proposed for the Lejes mill would use bagasse, and two mills under construc- tion are planning to use bagasse as one part of their fiber furnish. 12. Rice straw fibers are short and for that reason pulps manufactured from it are best used in grades where strength it not of primary importance. In particular, printing and writing papers of good quality can be made from rice straw and because of its relative abundance in Java, the principal direction of Indonesia's pulp and paper industry development has been the manufacture of printing and writing papers from rice straw. The better grades of printing and writing paper produced from straw include some proportion of long-fibered pulp which at present, must be imported. Another grade which can be produced satisfactorily from short fibered raw materials is corrugating medium, where the quality of principal importance is stiffness. In Europe and elsewhere, considerable quantities of corrugating medium are made from straw. However, although good quality paper of various types can be produced from rice straw, its use on a large scale has particular economic and technical disadvantages. 13. The principal technical disadvantage of rice straw is its relative- ly high silica content which makes the recycling and recovery of cooking chemicals difficult. This leads to high costs for pulping chemicals and a pollution problem which increases as plant size increases. The principal economic disadvantage is the relatively high cost of collection and trans- portation operations; if enough rice straw is to be collected for a moderately large-sized plant than the area over which it must be collected becomes so large as to raise transportation costs to prohibitively high levels. Moreover, because rice is a seasonal crop, rather large inventories must be kept at the plants during certain times of the year which further adds to the cost. 14. In Indonesia, there is enough rice straw (particularly in Java) to support substantial Expansion of this segment of the industry. However, for the reasons noted above, such expansion is likely to be limited to small additions to existing mills or the construction of new small-scale mills. Moreover the market requirements and proposed new construction are such that it is conceivable that the demand which can satisfactorily be supplied by paper produced from rice straw may be fully supplied. If some of the proposed mill developments which would use wood and bagasse were to proceed, there could be a real danger of an oversupply in the short-fibered portion of the domestic market. Under these circumstances, the rice-straw mills with their high cost structure and possibly lower product quality could be the most seriously affected. - 40 - 15. Bagasse is the fibrous residue left after sugar cane has been crushed to remove the sucrose and is used on a large scale for pulp and paper manufacture in many areas of the world. The bagasse is not usually a waste material as it is used as fuel in the sugar mills for steam and power produc- tion. Thus to the extent that the bagasse is used in this way, its cost is the cost of an alternative fuel in the sugar mill. The material can be readily pulped by a variety of processes. It is short-fibered, but within the range of products which can be satisfactorily produced with this type of fiber resource, it is one of the more highly regarded. Grades produced from bagasse to date have been primarily printing and writing paper and corrugating medium but plants are under construction in Mexico and Peru which will produce newsprint from bagasse. At this stage, however, this development is in its early stages and its technical and economic feasibility has not been fully demonstrated. 16. The Indonesian sugar industry is primarily in Central and East Java and thus pulp and paper developments based on bagasse are most likely to be located in these regions. The Lejes mill (which proposes a bagasse-based expansion) and the two mills under construction which will reportedly use some bagasse are all located in East Java. From a technical point of view, the construction of bagasse mills poses no particular difficulties but the economics require careful evaluation, particularly in considering the cost of fuel replacement in the sugar mills. Moreover, from the domestic market point of view, there is some danger of an oversupply of short-fibered grades as noted above. In this respect, bagasse-based mills are likely to be somewhat better off than those using rice-straw. Other Fibers 17. Other fibers of importance to the Indonesian pulp and paper industry are bamboo and waste paper. Bamboo is used in the Banjuwangi and Gowa mills and these mills are producing satisfactory grades of paper. However, because the harvesting of bamboo is often expensive, and regeneration is not always assured, both of these mills are investing in plantations of pine and hardwood species and thereby hope to improve both the security of their fiber resource supply and the quality of their products. So long as other less troublesome fiber supplies are available or can be developed, no new developments based on bamboo are likely. 18. Waste paper is widely used throughout the world in the manufacture of most grades of paper. The existing mills in Java use waste to the extent that they can obtain it, and at least two small mills in the Jakarta area produce cheap grades of tissue and board from a combination of waste paper and imported pulp. No estimates are available of the amount of waste paper recovered for this use in Indonesia but recovery rates in most countries of the world range between 20 and 40% of total paper consumed. Because of its basic low-cost advantage, Indonesian paper producers, particularly those favored by locations near large consumption centers, are expected to continue to develop the mechanisms for waste paper collection. - 41 - General Assessment 19. The preceding review of the various types of fibrous resources available to the pulp and paper industry shows that coniferous forest resourc,ss offer the best: potential for the large-scale development of a domestic or export oriented industry. Among the available short-fibered resourcess, bagasse probably offers the best potential for development but any bagasse-based project should be carefully evaluated against the alternative of developing fast-growing plantations of short-fibered pulp- wood spescies. C. Markets 20. Given the very large current levels of imports, the principal objective of any expanded production program should clearly be to increase the supply of paper and paperboard to the Indonesian domestic market. Never- the-less because Indonesia has substantial fiber resources, in particular long-fibered resources which are in short supply in Asia, the possibilities for exports should not be overlooked. Domestic Market 21. The most recent detailed study of the domestic market for paper in Indonesia was undertaken as part of a CIDA-financed study in 1971. The project[ons produced as part of this study remain the official estimates of the Department of Chemical Industries, but recent experience has shown that they are somewhat on the high side. The CIDA projections, and actual expe- rience, are compared in the following table. Projected and Act:ual Market for Paper and Paperboard, 1970-75 Year Consumption Actual 1/ Projected -------(thousand tons)------ 1970 148 140 1971 161 160 1972 183 190 1973 233 220 1974 234 260 1975 216 300 1/ Apparent consumption: domestic production plus net imports. - 42 - 22. The slackening in the rate of growth of demand which has been evident since 1973 is believed to be due to some slowing down in the rate of expansion of the Indonesian economy, coupled with the effect of very sharp increases in paper prices. 1/ Although the demand for paper and paper- board is expected to increase substantially over the next decade it is un- likely that the demand levels formerly projected can now be attained. Thus, in order to provide a reasonable basis for examining possible development strategies in the Indonesian pulp and paper industry, a reassessment of the likely market growth over the next decade must be undertaken. Any detailed market projections is beyond the scope of this survey but it is possible to review the assumptions upon which the previous projections were made, modify them in the light of recent experience, and thereby prepare a new set of preliminary projections which should be reasonably indicative of market demand in the medium term future. 23. The CIDA projections for the period to 1975 were based on an anti- cipated real economic growth rate (measured in terms of GNP) of 6.5% annually, and an elasticity of the per capita demand for paper with respect to per capita GNP of 4.1. In fact, over this period the economy grew at an average rate of 6.7% annually in real terms, but the income elasticity of paper demand was only about 2.0. Demand growth expectations in the CIDA study were clear- ly, in retrospect, overoptimistic. It would appear that the projections were influenced too much by the growth experienced during the period 1960-1970 when demand elasticity averaged a very high level of 5.8. Moreover, the dampening effect of the increase in paper prices was not anticipated. 2/ 24. To make new estimates of future demand, new assumptions regarding the growth of the economy, population increases, and the income elasticity of paper demand have to be made. The Second Five-Year Plan (April 1974 to March 1979) anticipates an overall growth in the economy of 7.5% annually. The official current estimate of population increase is 2.5% annually. Recent experience with actual paper consumption in the country show that the income elasticity of paper demand has averaged about 2.0. Projection of those data through 1980 give an overall figure for paper and paperboard consumption in that year of about 470,000 tons, compared with a current level of about 230,000 tons. This could be considered a somewhat optimistic projection of demand. 25. Other assumptions can be used to give a somewhat less optimistic view. Analysis of 1975 data for paper demand and per capita GNP in 26 Asian 1/ World paper and paperboard prices increased substantially during the period 1972-74 and this effect was compounded in Indonesia by increases in both duty and sales tax. Thus 1975 domestic prices for some grades are 2-3 times 1971 levels. 2/ Recent fluctuations in paper prices appear to have had some effect on demands in most areas of the world. However, this is a relatively new phenomena and price effects have not been reliably quantified. - 43 - countries shows a cross-sectional income elasticity of demand of 1.4 1/. In individual countries, the elasticity is higher at low consumption levels but may eventually be expected to approach this figure. Thus for the next five- year period, lowering the elasticity from the recent experience figure of 2.0 to, say, 1.7 might be considered appropriate for Indonesia. If, over the same period, real economic growth averaged only 5% annually, then paper and paperboard consumption by 1980 could be expected to reach a level of about 350,000 tons. This could be considered a somewhat pessimistic projection of demand. 26. The best estimate of actual demand in 1980 probably lies somewhere between the two rough projections developed above. The arithmetic average of the two projections (410,000 tons total demand in 1980) implies a growth rate over the next 5 years of about 10% per annum. This seems reasonable in the light of: the rates of growth which have been experienced in the past, as shown in the following table: Overall Growth in Consumption of Paper and Paperboard Average Annual Period Growth 1965-70 Actual 15% 1970-75 12% 1975-80 Projected 10% The observed gradual decline in the rate of growth is normal, reflecting a lowering income elasticity at higher income levels. Thus, for the period 1980-85, a somewhat lower rate of growth, say 8%, would appear to be appro- priate. 27. The following table shows tentative projections on this basis for 1980 ancl 1985, broken down into major grade groups using current grade dis- tribution experience in Indonesia together with observed trends from other countries. A detailed market review would analyze the plans and prospects of paper-consuming industries to relate these abstract statistical projections to physical developments within the country. However, even without this refinement, the demand projections tabulated should be realistic enough to provide at least a tentative market framework within which a number of dev- elopment: stategies can be formulated. 1/ Cross-sectional analysis also shows that the present level of paper and paperboard consumption per capita of about 1.8 kg is very close to the level which would be anticipated from the GNP, suggesting that there are no major distortions in the Indonesian paper and paperboard market. - 44 - Tentative Projection of Domestic Paper and Paperboard Demand Grade Demand Current 1/ 1980 1985 … --- (thousand tons)---------- Newsprint 50,000 82,000 110,000 Printing 75,000 123,000 166,000 Kraft Packaging Grades 40,000 82,000 130,000 Other Packaging Grades 31,000 67,000 114,000 Cigarette Paper 8,000 10,000 12,000 Other Grades 26,000 46,000 68,000 Total 230,000 410,000 600,000 1/ Approximate: based on recent production and import data. Export Market 28. Although world production and consumption of paper and paperboard is currently of the order of 140 million tons annually, a great deal of this is produced and consumed in the same country, and a substantial amount of the balance moves between neighboring countries within Europe, or between Canada and the United States. Thus the true extra-regional market for paper, in which exported products from Indonesia would have to compete, is only about 8 million tons annually, or 5% of total world production. Similarly, the extra-regional market for pulp is about 7 million tons out of a total produc- tion of 120 million tons. About three-quarters of this tonnage of both pulp and paper originates in Scandinavia and North America, and is shipped to a variety of countries throughout the world. 29. Detailed grade information concerning those shipments is not reliably available but the following estimates have been developed from a variety of sources. - 45 - Approximate Current Extra-Regional Trade in Pulp and. Paper Grade Shipments (million tons) Paper - Newsprint 2.9 - Printing & Writing Paper 1.2 - Kraft Paper & Board 2.6 - Other Paper & Board 1.3 - Total 8.0 Pulp - - Bleached Kraft 4.0 - Un.bleached Kraft 0.7 - Dissolving Pulp 0.9 - Sulphite Pulp 0.8 - Other 0.6 - Total 7.0 30. Among the paper grades, newsprint and kraft paper and paperboard dominat:e and these could readily be produced in Indonesia using the pine and agathis resources previously described. Imports of these grades in the region are as follows: Imports of Kraft Grades and Newsprint in Selected Asian Countries, 1974 Imports Newsprint 1/ Kraft Grades 2/ -----(thousand tons)--- Indonesia 63 40 Malaysia 32 40 Singapore 36 40 Thailand 56 2 Hong Kong 57 50 Total of Selected Countries 244 172 1/ FAO Yearbook of Forest Products. 2/ Estimated. - 46 - 31. Indonesia is one of the major importers in the region and clearly any program of domestic production should be initially aimed at filling domestic demand. Nevertheless, the regional deficit in these grades is substantial and is unlikely to diminish significantly in the medium term future because of the lack of suitable fiber resources in the countries listed. It is apparent that production of these grades from any new plant which may be built could be marketed in neighboring countries where Indonesia is likely to have a freight advantage over the traditional suppliers in Scandinavia and Canada. 32. Of the pulp grades listed, bleached kraft pulp is dominant in world trade. Moreover almost all of the growth which has taken place in world pulp trade has been in this grade. Both long-fibered and short-fibered grades of bleached kraft pulp are marketed. While it is conceivable that Indonesia could produce long-fibered pulp for export, the domestic demand for all-long- fibered grades is so great as to make this development unlikely. The inter- national market for short-fibered pulp has grown rapidly in recent years and FAO estimates that some 4 million tons of new capacity (much of it in Latin America) will come on stream in the next five years. The recent downturn in the major economies of the world sharply reduced pulp and paper demand during 1975 and 1976 and while there has been a substantial recovery, it now appears that there could conceivably be some excess short-fiber pulping capa- city in the early 1980s. If this situation occurs, then competitive advantage and disadvantage will determine which supplies are the most seriously affected and for Indonesia, the following factors would have to be considered. (i) At least initially, any short-fibered pulp produced in Indonesia in a plant scaled for the export market would have to be produced from dipterocarps and mixed tropical hardwoods. The competitiveness of these grades in international markets is not known; (ii) Wood costs from indigenous tropical forests are usually found to be higher than wood from plantation forests in those countries (such as Brazil) which are developing substantial export pulp industries using established plantation species; and (iii) New plant construction costs have risen dramatically in the past 2-3 years and a new Indonesian producer would be competing, at least to some extent, with the owners of older, lower cost plants. 33. While these factors do not exclude the possibility of an export- oriented pulping operation in Indonesia they do suggest that in view of the danger of possible over-supply, prior marketing arrangements for a substantial proportion of the tonnage would have to be made. This is particularly important because there is little justification for believing that Indonesia would have any competitive advantage in producing and marketing short-fibered bleached kraft pulp. - 47 - 34. In general, export markets for pulp and paper are likely to be quite good for the long-fibered grades (such as newsprint, kraft paper and pulp) and not so attractive for the short-fibered grades. Whereas Indonesia does have long-fibered pulpwood resources, these are not so extensive as to allow the contemplation of a large-scale export-oriented pulp and paper industry, particularly since the supply to the domestic market is so seriously deficient. Nevertheless, the export market could provide a valuable outlet for a proportion of the output for plants aimed primarily at the domestic market, allowing them to be built in an economic size range. B. Development of Alternative Development Strategies Alternat:ives for Consideration 35. Future development of the pulp and paper sub-sector in Indonesia could follow one of a number of alternative strategies and the following analysis is an attempt to ascertain the costs and benefits associated with these alternatives. Considering only the supply to the domestic market, the strategies which could be considered include: (i A halt in construction of new capacity after those plants already started are completed. Under this alternative capacity would remain at the 160,000 ton level, and paper requirements above this figure (together with the 70,000 tons of pulp required to support this domestic production) would be imported; (ii) A continuation of the construction and expansion of small plants, using agricultural residues and imported pulp, to maintain the anticipated 1980 level of self-sufficiency in specified grades. Other grades, and the pulp required to support domestic production, would continue to be imported; and (iii) The construction of suitable large integrated pulp and paper mills to obtain a high degree of self-sufficiency in most paper grades. These mills could also supply pulp to the existing plants. 36. Actual development could, and probably will, encompass all of these strategies to some extent. The following preliminary comparative analysis treats them as independent options and provides some insight into the relative merits of each. It is hoped that the results will be useful to the Government in making decisions aimed at influencing the development of this sub-sector. - 48 - Basic Assumptions 37. The assumptions basic to the formulation of the strategies are as follows: (i) The construction of new plants required would take place over a 10-year period beginning in 1978, with all new plants in operation by 1988 to meet supply objectives based on the projected 1990 market; (ii) Fibrous resources would be available to meet the projected needs of the various plants discussed below; and (iii) All costs and benefits are projected in terms of constant 1977 prices for the period 1978-2000. Market Assumptions 38. Tentative projections of the domestic market to 1985 have been developed previously in this Annex (para. 27). Consumption in subsequent years has been estimated by applying a further overall 8% annual growth rate to the 1985 figure, with some adjustments for individual grades. Total consumption of paper and paperboard in 1990 would thus be 880,000 tons. 39. Under the alternative development strategies proposed, the require- ments of the market in 1990 would be met as follows: Supply and Demand Balance in 1990 under Alternative Development Strategies Supply Strategy 1/ Strategy 2 -/ Strategy 3/ Grades Demand Domestic Imports Domestic Imports Domestic Imports Newsprint 160 - 160 - 160 160 - Printing & Writing 240 112 128 190 50 190 50 Kraft Packaging 190 - 190 - 190 170 20 Other Packaging 170 45 125 120 50 120 50 Cigarette Paper 17 3 14 10 7 10 7 Other 103 - 103 - 103 - 103 Total 880 160 720 320 560 650 230 Pulp Imports 4/ - 70 - 140 - 0 Self-sufficiency 18% 36% 74% 1/ No new plants after 1980. 2/ Continue building small plants to maintain 1980 level of self-sufficiency. 3/ Construct large plants. 4/ Pulp demand varies according to strategy. - 49 - 40. The prices used to measure the cost of imports in this analysis are an average of the very high prices which prevailed in 1974, and the much lower prices which are in effect at the moment as a result of a tem- porary oversupply in Japan and elsewhere. The values are an attempt to represent a true "1977 price" (CIF) in terms of long-range trends and are shown in the following table: CIF Prices for Imported Paper Grades Price 1/ (US$/ton) Newsprint 450 Printing & Writing 650 Kraft Packaging 500 Other Packaging 350 Cigarette Paper 900 Other 700 Pulp 500 1/ Average for various types included in the broad grade categories listed. Details of Strategy 1 41. By 1978, all of the mills presently under construction would be in operation giving an effective domestic production capacity of 160,000 tons oi paper and paperboard. Actual production would reach this level in 1982. Under this strategy no new mills would be constructed in the period 1978-2000, and thus no investment would be required. Costs incurred during the period would comprise: (i) The cost of pulp and paper imports; and (ii) The cost of production in the existing mills, estimated to average $500 per ton for paper pro- duced from domestic pulp, and $150 per ton (ex- cluding the cost of pulp) for paper produced from imported pulp. Details of Strategy 2 42. In this strategy, domestic production would continue to increase as small mills are constructed to maintain a high level of self-sufficiency for those grades which can readily be produced with the technoLogy and fibers available for this type of mill. Based on experience in Indonessia and else- - 50 - where, it has been assumed that 80% of the total demand for printing and writ- ing papers, 70% of the demand for non-kraft packaging papers and 50% of the demand for cigarette papers are levels which can be realistically reached and maintained in Indonesia. Thus in projecting costs for this strategy, it has been assumed that new mills would be built between 1978 and 1990 to maintain those levels of self-sufficiency in the face of growing demand over this period. Domestic production in 1990 would amount to 320,000 tons annu- ally; imports would be 560,000 tons. (It is obvious that new mills would continue to be built after 1990; however, in this analysis construction after that date has not been considered as the benefits of further new mills would not be substantially realized before the end of the projection period). 43. Cost incurred during the period would comprise: (i) The cost of importing pulp and paper not supplied by the domestic industry; (ii) The cost of constructing the new capacity required, estimated to be $550,000 per daily ton of capacity; 1/ and (iii) The cost of production in the existing and new small mills estimated to average $500 per ton for paper pro- duced in mills manufacturing their own pulp, and $150 per ton (excluding the cost of pulp) for paper pro- duced from imported pulp. Details of Strategy 3 44. For this strategy it is assumed that domestic mills would be constructed to produce by 1990: (i) 100% of all newsprint; (ii) 80% of all printing and writing paper; (iii) 90% of all kraft packaging grades; (iv) 70% of all other packaging grades; (v) 50% of all cigarette paper; and (vi) 100% of all pulp. 1/ This is a relatively low figure, reflecting the experience of actual small-mill construction in Indonesia to date, and the fact that some of the new capacity is for paper-making only, using imported pulp and not requiring integrated pulping capacity. - 51 - Overall, this represents 74% of all of Indonesia's projected pulp and paper requirements which is a realistically attainable objective. 45. In physical terms, it has been assumed that this capacity would be achieved by: (i) Building four moderately-sized mills, which would use a mixture of agricultural residues and pulp from another mill to be established to maintain, pro- jected self-sufficiency levels in packaging, cig- arette, printing and writing grades; (ii) Building one chemical pulp mill in the early 1S980's to supply the existing industry and the four mills described above, and subsequently expanding it; (iii) Building one large kraft paper and board mill in the early 1980's, and subsequently expanding it; and (iv) Building one newsprint mill in the early 1980's and subsequently expanding it. 46. Costs for this strategy include: (i) The cost: of importing the paper grades which would not be supplied by the existing industry; (ii) The cost: of constructing the new capacity required. For the moderately-sized mills without full pulping capacity, an average of $550,000 per daily ton of capacity has been used. For the large integrated mills, $650,000 per daily ton has been used. These figures reflect experience in other regions and allow for a moderate degree of associated infrastructural development; and (iii) The cost. of production in the new large mills esti- mated at an overall average of $220 per ton, in the existing small mills estimated at the same levels as for Strategy 1, and in the new moderate-sized mills at $150 per ton for the non-integrated and $300 per ton for the integrated capacity. Compar:Lson of Strategies 47. The three strategies are compared and the results discussed in Paras. 7.22 - 7.25 of Chapter VII. - 52 - E. Potential Pulp and Paper Products 48. The tentative program of large mill construction developed in The preceding paragraphs included: four medium-sized, partially inte- grated mills to produce printing, writing and packaging grades; a chemi- cal pulp mill; a kraft paper and board mill; and a newsprint mill. The analysis in Chapter VII shows the overall profitability of this program to be somewhat more attractive than importing paper, with substantial improvement if world paper prices increase as expected. If a program of large mill construction is to be embarked upon, it is evident that some ranking of the projects within such a program should be undertaken in order that project priorities can be assigned. 49. At least six mills which would fit into such a program have been proposed as projects in Indonesia. In some cases foreign partners have been found, the necessary licenses obtained, and timber concession agree- ments reached. Nevertheless at the present time, not one of these projects is being implemented and in most cases, there had been no notable progress towards implementation in the past 1-2 years.1/ In the following analysis, the projects are taken more or less as proposed, and preliminary cost and benefit analyses are presented. Outline of Projects 50. The six projects to be compared are listed below. It should be noted that some of these projects would be complementary in supplying the domestic market in Indonesia, others would be competing for the same market. (i) Aceh: an unbleached kraft paper and board mill which at full capacity would produce 170,000 tons per annum of sack kraft paper, linerboard, and other kraft paper for the domestic market; (ii) South Sumatra: a bleached kraft pulp and paper mill which at full capacity would produce 80,000 tons per annum of printing and writing paper, and 100,000 tons per annum of pulp, all for the domestic market. (iii) Central Java: a newsprint mill which at full capa- city would produce 160,000 tons of newsprint for the domestic market. The 24,000 tons of chemical pulp required for this production would be manufactured elsewhere; 1/ The reasons cited for this lack of progress include high costs of infrastructure, high costs generally, low profitability pro- jections and the difficulties of assuring a wood supply. - 53 - (iv) East Java: a bagasse-line addition to the Lejes mill to produce 45,000 tons of printing and writing paper for the domestic market; (v) South/Central Kalimantan: a 200,000 ton per annum long and short-fibered bleached kraft pulp mill. By 1990, as much as 140,000 tons of this product could be sold in Indonesia, the balance would have to be exported; and (vi) East Kalimantan: a 200,000 ton per annum short-fibered bleached kraft pulp mill. By 1990, approximately 70,000 tons of this product could be sold in Indonesia, the balance would have to be exported. The Aceh Project 51. A 40,000 hectare concession of natural pine forest has been granted to P.T. Atlas Helau, an Indonesian company. Preliminary studies have been undertaken which suggest that a kraft paper and board mill in this region could be feasible. The mill would initially be constructed to use the exist- ing resource, but concurrently pine plantations would be established close to the mill site for future utilization. At the present time, the company is carrying out some nursery and plantation trials but detailed studies for the project have yet to be prepared. 52. For this analysis, it has been assumed that the mill would be de- signed to produce 90% of the projected Indonesian demand for kraft paper and board in 1990, namely 90,000 tons of sack kraft paper, 60,000 tons of linerboard, and 20,000 tons of other kraft paper for a total production of 170,000 tons per annum. Having regard to the projected growth pattern of the demand, the mill would logically be constructed in two stages. The first stage would come on stream in 1982, with a design output: capacity of 120,000 tons annually. Provision for expansion would be included where appropriate and the whole mill would be expanded to its ultimate capacity of 170,000 tons in 1987. 53. The estimated capital cost of the project in terms of 1977 prices, is as follows: - 54 - Estimated Capital Cost of Aceh Kraft Paper and Board Mill Item Amount (US$ million) Plant Capital 335 Working Capital 15 Training and Management 12 Logging Operations 10 Plantation Establishment 27 Townsite 11 Total 410 The South Sumatra Project 54. This project was conceived as a productive way to utilize large areas of degraded forest land in South Sumatra, by establishing planta- tions of pine to supply a pulp and paper mill. This concept was developed as part of a Sumatra Regional Planning Study undertaken for the Government of Indonesia by an American consulting company, Robert Nathan Associates Incorporated of Washington, D. C. As proposed by Nathan the mill would produce 300,000 tons annually of a mixture of bleached pulp and printing and writing papers, using pine from the plantations to be established and existing resources of mangrove. 55. For this analysis, the project has been scaled down to match the projected domestic demand for printing and writing papers and for bleached pulp in 1990. This gives a total capacity of 180,000 tons an- nually, 80,000 tons of which would be printing and writing paper, the balance pulp for sale. This mill would commence operation in 1985. 56. The total estimated capital cost of this project, in terms of 1977 prices, is as follows: Estimated Capital Cost of South Sumatra Pulp and Paper Mill Item Amount (US$ million) Plant Capital 300 Working Capital 20 Training and Management 5 Logging Operations 8 Plantation Establishment 27 Townsite 5 Total 365 - 55 - The Central Java Project 57. A concession to cut Pinus merkusii located in Central Java has been granted to an Indonesian company (PT Anem Kesong Anem) together with a license to build a 60,000 ton per annum newsprint mill. A subsequent ex- pansiorn to 99,000 tons capacity has been proposed. The company has made partnership agreements with a Canadian company (Kruger) and a Hong Kong company (UDI) but the project is not progressing at the present time, prob- ably because of the high cost of plant construction and infrastructure de- velopment. The project as conceived would use the pine from Central Java for the mechanical pulp portion of the newsprint furnish, and would import semi-bleached long-fibered pulp as required for the chemical pulp portion. 58. For this analysis, the project concept has been modified slightly to betl:er meet the projected newsprint requirements in Indonesia. It has been assumed that the mill would be constructed with an initial capacity of 120,000 tons annually, to commence operation in 1982, and would subsequently expand to 160,000 tons to match the projected 1990 market demand. 59. The total estimated capital cost of this project (including the expansion), estimated in terms of 1977 prices, is as follows: Estimated Capital Cost of Central Java Newsprint Mill Item Amount (US$ million) Plant Capital 180 Working Capital 20 Training and Management 8 Logging Operations 12 Townsita 5 Total 225 The Eazst Java Project 60. This project has been conceived by the Government-owned Lejes Pulp and Paper Mill as a major expansion project raising output from 24,000 tons to 69,000 tons annually. The addition would, in effect, be a com- pletely new pulp and paper mill which would utilize bagasse from adjacent sugar mills. The current operations at Lejes are using rice straw. The company has discussed possible financing for this project with Canada and Abu Dhabi but at the present time, no full scale feasibility study has been undertaken. - 56 - 61. For this analysis it has been assumed that the project would con- sist of 45,000 ton per annum mill producing printing and writing paper from bagasse pulp. All of this output would be consumed in the domestic market. The mill would commence operation in 1982. 62. The total estimated capital cost of this project, in 1977 prices, is as follows: Estimated Capital Cost of East Java Fine Paper Mill Item Amount (US$ million) Plant Capital 124 Working Capital 8 Training and Management 4 Townsite 4 Total 140 The South/Central Kalimantan Prolect 63. This project is being promoted by a French company who has formed an Indonesian subsidiary (Sopramar) to act as project sponsors. Its design is based on the belief that in a region which is presently being exploited for export logs, primarily dipterocarps and ramin, there are large stands of long-fibered agathis and araucaria. As conceived, the proposed pulp and paper mill would use non-commercial trees of both hardwood and softwood species to produce 200,000 tons of paper annually for the domestic and export markets. 64. For this analysis, the project concept has been modified to better meet the needs of the Indonesian market.n-commercial trees of both hardwood and softwood species to produce 200,000 tons of paper annually for the domestic and export markets. 64. For this analysis, the project concept has been modified to better meet the needs of the Indonesian market. Specifically it has been assumed that the mill would produce 200,000 tons of pulp (about one- half of which would be from softwoods), but no paper, and that 70% of this pulp could be marketed domestically. The remaining 30% would be exported but because this would be a little-known grade of pulp pro- duced from tropical hardwoods, a 10% discount below current world prices for hardwood pulp has been allowed. The mill would commence operations in 1982 and reach full production in 1987. It would not be until 1990, however, that the domestic market could absorb 140,000 tons of pulp and in the intervening years additional exports would be required. - 57 - 65. The total estimated capital cost of this project, in terms of 1977 prices, is as follows: Estimated Capital Cost of South/Central Kalimantan Pulp Mill Item Amount (US$ million) Plant Capital 302 Working Capital 19 Training and Management 10 Logging Operations 8 Townsite 11 Total 350 The East Kalimantan Prcject 66. This project is being investigated by the Austrian Government as a prelude to possible Austrian involvement in its implementation. It would pro- duce pulp and paper for the domestic market and for export, using those grades of tropical hardwoods which are not now commercially exploited. The project has no formal sponsor as yet but Inhutani, a Government-owned forestry com- pany, has large concessions in the area under consideration and is working closely with the Austr:ians in evaluating the project. 67. For this analysis the project has been considered as producing only pulp, at a capacity of 200,000 tons annually. Because this pulp would be entirely a hardwood grade, a smaller proportion of it could be consumed domestically than in the case of the South/Central Kalimantan mill. It has been assumed that the mill would start-up in 1982 and that donestic sales would reach and stabilLze at 70,000 tons by 1990. The balance of production would be exported, at prices discounted from current world pr:Lces by 10%. Although there would undoubtedly be physical differences between this pro- ject and that of South/Central Kalimantan, it has been assumed for this analy- sis that overall capital investment requirements would be the same. Summarv of Results 68. Paragraphs 7.29 - 7.32 of Chapter VII contain a presentation and discussion of the results of preliminary financial and economic analyses for each cf the six projects examined. The overall conclusions and recommenda- tions arising from this study of development options in Indonesia's pulp and p&per industry are also presented in Chapter VII. - 58 - VIII. THE ENGINEERING INDUSTRIES Introduction 8.01 The engineering industries are an important element of the manu- facturing sector in Indonesia, with products ranging from fabricated steel and other metals to complex machinery, components and intermediate goods, vehicles, small ocean-going ships and, recently, light aircraft assembly. Despite various economic and technological difficulties, this subsector has grown considerably since the 1950s and now employs more than 100,000 people. In addition to an assessment of problem areas and reviews of specific project, this report drew attention to the need for an effective long-term strategy in planning its future development. 8.02 The objectives of the 1976 subsector study were to assess the pro- gress made by the industry and to identify possible project or investment opportunities for the next stage of development. The latter was taken to cover the period five to eight years ahead. Particular emphasis was given to the major constraints or obstacles affecting development to determine possible measures to deal with them. The study has concentrated on metal products, mechanical machinery and electrical industries although some aspects of the automotive industry were also covered. In this connection, visits were made to typical firms in the Jakarta, Surabaya and Bandung industrial centers. Discussions were also held with the Ministry of Industry and representatives from leading manufacturers' associations. 8.03 This chapter is in two parts. First, it contains a general review of the engineering industries in Indonesia in terms of structure, technology, and existing constraints on performance. Particular reference is made to the problem of imports and the factors which affect the ability of domestic firms to compete. It then discusses questions of overall strategy, emphasiz- ing important areas of uncertainty which need to be resolved. It also out- lines a number of possible development projects which would strengthen the existing product range and facilitate the industry's future growth. Present Status of the Industries Size and Structure 8.04 The engineering industries have expanded steadily over the five years since 1971. Whilst accurate statistics covering the whole of this period were unfortunately not available to the 1976 mission, it is clear that the subsector has more than doubled in size. This is confirmed by the growth in output that has taken place, the production rates of key engineering products *that have been achieved, and the increases in employment recorded since then. Table 8.1 shows that output in value added terms from large- and medium-scale - 59 - engineering firms, other than the automotive industry, increased from Rp 14.4 billion in 1971 to Rp 28.9 billion in 1973 (at constant 1973 prices). This is based on the relevant surveys of manufacturing industries. 1/ Also shown are estimates for 1975, indicating further growth in line with the data presented in Chapters I and II of this report. 8.05 This growth has been achieved despite cutbacks associated with the world-wide recession in 1973/74 which affected the demand for steel products and heavy equipment. The explanation for this is to be found in the increases in sales of consumer goods since then, notably household appliancles, and the emergence of new industries in the electrical equipment and electronic prod- uct areas. An indication of the volume and range of engineering products currently made in Indonesia is given in Table 8.2. These items account for a large proportion of grosS output from the whole subsector which totalled Rp 601 billion in value during 1975. Production rates for 1969 are also shown. 8.06 Significant increases in production have been made in nearly every case. Output of heavy steel structures, for example, rose by a factor of five between 1972 and 1975 to reach 40,000 tons. Production of machinery and spares advanced from 3,000 tons in 1971 to an estimated 8,000 tons in 1976. The output of road rollers also increased, boosted by the introduction of 100% protection. Considerable expansion has taken place in electronics, where the production of radio and television receivers increased Erom 416,000 and 65,000 respectively in 1971 to 1,100,000 and 166,000 in 1975. In 1976, the number of television s-ets produced is expected to reach 200,000. 8.07 The growth of the automotive industry has been spectacular, espe- cially since the ban on CBU cars was imposed in January 1974. Primarily an assembly operation, the output of passenger cars and commercial vehicles now totals some 86,000 units compared with 16,000 in 1971 and only 5,000 in 1969. This has, however, been achieved more by the introduction of new makes and models than the expansion of existing lines. Operating costs remain extremely high, with average prices more than three times the landed equiva- lents. Despite the proliferation of vehicle types, production of a limited range of automotive compon,ents began during the period. These in,zluded mufflers (15,000 in 1975), shock absorbers (30,000), pistons (50,000) and brake linings (19,000 sets). A number of truck chassis were also made (1,000). 1/ The data for the automotive industry has been excluded to minimize the distortion that would otherwise occur because of differences in oper- ating margins and taxation levels, and the changes resulting from the total ban on CBU passenger cars from January 1974. - 60 - Table 8.1 INDONESIA: Output from Large - and Medium - Scale Engineering Industries, 1971-75 Item Value Added 1971 1973 1975 L1 ---------billion Rupiah----------- At Current Prices Metal Products 4.2 12.4 21.8 Mechanical Machinery 0.6 4.0 ) Electrical, Electronics 3.5 9.3 ) 24.6 Transport Equipment /2 0.7 3.2 ) Total Engineering 9.0 28.9 46.4 Total Manufacturing 181.3 402.9 693.0 At Constant 1973 Prices Metal Products 6.7 12.4 17.3 Mechanical Machinery 1.0 4.0 ) Electrical, Electronics 5.6 9.3 ) 19.5 Transport Equipment 1.1 3.2 ) Total Engineering 14.4 28.9 36.8 Total Manufacturing 289.2 402.9 548.7 /1 Growth rates of 18% per annum estimated for engineering and 16.7% for manufacturing industry as a whole between 1973-75. /2 Excludes automobile and motorcycle industries. Source: CBS Surveys of Manufacturing Industries. - 61 - Table 8.2 INDONESIA: Production of Selected Engineering Products Product Unit 1969 1971 1973 1975 1976 Est. Metal Products Light Steel Construction 000 tons - - - 1.5 N/A Heavy Steel Construction 000 tons - 8(1972) N/A 40 N/A Bolts and Nuts 000 tons - - - 2 N/A Steel Wire 000 tons - - - 36 N/A Mechanical Machinery Machinery and Spares 000 tons 2.4 3 8 8 8 Hullers 000 pcs. 2.3 - 3.5 4 5 Sprayers 000 pcs. 20 - - 20 25 Water Pumps 000 pcs. 0.9 - - 2 2 SewirLg Machines 000 pcs. 14 292 500 520 550 Diesel Engines 000 pcs. - - - 11 12 Road Rollers units 200 200 360 575 600 Electri'cal. Electronics. Etc. Transformers units N/A N/A N/A 630 N/A Elect:rical Cable 000 tons - - 7 9 9 Lamps 000 pcs. 3.5 6 18 21 25 Radio Sets 000 pcs. 363 416 900 1,100 1,200 Television Sets 000 pcs. 4 65 70 166 200 Refr:igerators 000 pcs. - 21 10 37 40 Air Conditioners 000 pcs. 4 32 20 23 25 Car I3atteries 000 pcs. 32 262 140 220 240 Dry-Cell Batteries Mill. pcs. 54 72 132 180 250 Transistors Mill. pcs. - - - 3.8 N/A L.E.D.s Mill. pcs. - - - 2.4 N/A Transport Equipment Automobiles 000 units 5 16 37 79 86 Motorccycles 000 units 21 50 150 300 350 Shipbuilding 000 Dwt. - - - 19 23 Ship Repairs 000 Dwt. - - - 775 N/A Aircraft units - - - 1 24 Note: The years are fiscal years. Source: Department of Industry 26 August 1976 and Almanak Industri 1976. The Production shown for heavy steel construction in 1972 is taken from the 1973 Sector Study by FGU-KRONBERG/KU Gummersbach. - 62 - 8.08 Several new products have appeared since 1971 and some examples of these are also shown in the table. Perhaps the most notable development in terms of the engineering know-how and skills required is the start of diesel engine manufacture in Indonesia. In 1977 no less than six different types are expected to be in production. The project being undertaken by the State- owned P.T. BBI to make Deutz diesel engines under license at Surabaya is particularly interesting. With assembly already underway, new machinery is being installed which will enable 45% of the machining content to be done locally. Buying imported materials in the first instance, they hope to use domestically produced castings and forgings when these become available. At a later stage, local content is planned to rise first to 60% and then to 80%. 8.09 By far the greatest number of new products to be manufactured over the last three to four years has come from the fast-growing electronics industry. A high proportion of these are sold to domestic consumers, such as locally assembled televisions and cassette players, but there is a small but increasing range of electronic products being made exclusively for export. Two examples of these are light emitting diodes and linear integrated cir- cuits. It must be pointed out, however, that the three major suppliers simply "sell" their output to another subsidiary of the parent company (e.g., Monsanto, Fairchild) and are not generating genuine markets. They are simply one stage in an integrated operation. Manufacturers of this type of product are able to import materials and equipment duty free on the bonded warehouse principle. As a result of these and other measures to promote exports in this subsector, the value of electronics goods other than instruments shipped abroad has risen rapidly and in 1975 totalled US$6.6 million. Preliminary results for 1976 suggest that this will be more than doubled. Exports from other engineering industries were negligible in comparison. Employment 8.10 The numbers employed in the engineering industry almost doubled between 1971 and 1973, before the economic recession took full effect. This is clear from the comparisons for large- and medium-scale firms shown in Table 8.3, where the industry totals rose from 36,000 in 1971 to 71,000 in 1973. The fastest growth in employment was recorded by the mechanical machinery and electrical industries which both increased by a factor greater than three times. Employment in the transport industries also more than doubled. In contrast, the metal products group while still dominant in the total number of establishments and employment, expanded by less than a third. 8.11 The results for 1975 indicate a much more modest rate of growth from 1973 compared with 1971-73, with a virtual standstill outside the metal prod- ucts group. It must be emphasized, however, that these statistics are based on preliminary data which probably underestimate the true position - possibly by as much as 20% for a particular group. This view is based on previous experience, and is supported by the significant increases in output reported for a wide range of engineering products between 1973 and 1975. The results for 1975 are also complicated by a change in classification affecting medium- and small-scale firms. Formerly, establishments with five to nine workers not using power were excluded from the returns. This appears to account for much of the increase in employment shown for the metal products group. - 63 - Table 8.3 INDONESIA: Employment in Large- and Medium-Scale Engineering Firms, 1971-75 Industrr Group No. of Establishments Employment (000's) 1971 1973 1975 1971 1973 1975 Metal Products 720 942 2,490 21 27 42 MechanicaL Machinery and EquLpment 44 155 245 4 13 11 Electrical Machinery, Electronics, etc. 78 95 160 5 1.6 15 Transport Equipment 305 182 337 6 1.5 18 Total L,147 1,374 3,232 36 71 86 Note: The 1971 statistics cover power-using establishments with five or more workers and establishments with ten or more using no power. The statistics for 1975 are preliminary results, and include all establishments with five or more workers. Source: CBS Surveys of Manufacturing Industry. Technical Considerations Technological Change 8.12 Perhaps the most striking of the many changes that have taken place in the engineering industry over the last five years or so has been the way in which technology has developed. Much of this, of course, has resulted from the introduction of new products especially in the electronics industry. But there have also been significant advances in the more traditional metal products and heavy engineering areas. Some of these were foreshadowed earlier, for example, the regional foundry centers which should make a considerable impact in, terms of improved product quality when fully operational. Several factories using modern technology and equipment have also been built to make such products as diesel engines and electric power cables. 8.13 Technological change is also noticeable in many of the older engi- neering concerns, although some that were originally set up as repair shops. - 64 - Although there is still a demand from the industry's customers for pre-war machinery spares, they are increasingly replacing obsolete plant by more up-to-date equipment. The requirement for modern designs has also been boosted as a result of various projects undertaken during Repelita I and II. In line with this trend, considerable product diversification has taken place in engineering. In some instances, joint ventures have been established with foreign partners to manufacture machinery and equipment which would otherwise have to be imported. Agricultural tools and centrifugal pumps are examples of these. Several firms have turned to making structural steelwork as the demand for some of the foundry-based products has declined or become unpro- fitable. 8.14 The process of technological change is continuing, but it is also expensive. Some indication of the order of investment likely to be made in the engineering subsectors over the next two years or so is given by Table 8.4. This is based on the applications registered with the Directorate- General of Basic Industries as of November 1976, and summarizes the foreign and domestic capital requirements for various projects in the four main product groupings. It can be seen that the projected investment for the transport subsector is considerably more than the others. However, almost half this is accounted for a single shipbuilding project worth US$29 million. 8.15 The investment projected for the mechanical machinery group is significantly higher than that for the electrical and electronic industries and approximately equal to that for transport equipment other than ship- building. The range of products includes tea processing and sugar machinery, Table 8.4 INDONESIA: ProJected Investment for the Engineering Industry (as at November 1976) Foreign Investment Domestic Investment No. Value US$ Million No. Value Rp Billion Metal Products 5 19.7 Mechanical Engineering and Equipment 13 31.2 Electrical Machinery, Electronics, Etc. 10 21.6 5 3.12 Transport Equipment 13 53.5 3 2.31 Total 41 128.0 8 5.43 - 65 - boilers and overhead travelling cranes, and two projects involve diesel engine manufacture. Small electric motors and generators are notably new products in the electrical industry group, whereas the main emphasis in the tranLsport subsector is on automotive components. The latter includes radiators, pistons, filters and brake linings, and also front forks and shock absorbers for motorcycles. Condition of Plant and Machinery 8.16 The poor condition of machine tools and other plant continues to give cause for concern. Although re-equipment has taken place since 1971, out-dated and badly maintained machinery still predominates in the small- and medi:um-size firms. Several examples were noted during visits by the mission,, and it is clear that little progress is being made in dealing with this problem. There is, however, one notable development - the rehabilita- tion center now being established in Surabaya by P.T. Barata. When fully operational this will be capable of reconditioning about eight machines a month. Unfortunately, with an estimated 60% of their own machines requir- ing attention, there is unlikely to be any capacity for other companies' machines for at least three years unless the planned facilities are con- siderably expanded. 8.17 In 1972 it was estimated that 8,500 machine tools out of a total of some 14,000 needed repair, although of these only 6,000 were worth over- hauling. 1/ The remainder of 2,500 should be scrapped. Thus a single unit processing some 100 machines a year is unlikely to make a significant dif- ference. However, at the time the original survey was carried out, the mix of machine types was found to be at variance with that commonly found in industrialized countries, particularly with regard to lathes, drills, and shapers used in repair and rehabilitation work. These accounted for 48% of the total, half as much again in comparison to industrialized countries, which reflects the heavy demand for repair work in Indonesia. With the changes in technology tlnat have already occurred and are likely over the next decade, many of the existing machine tools will almost certainly be- come redundant thereby reducing the numbers to be overhauled. Although this would clearly ease the problem, it would by no means eliminate it. Machine Utilization 8.18 It was clear from the visits to various factories that machine utilization, other than possibly in the electronics industry, is still a majQr problem. Whole departments or machine sections were found to be idle for lack of work; single shift work is also predominant. This is true of factories built within the last five years as well as old established con- cerns, and applies to both public and privately-owned companies. Data for machine utilization were difficult to obtain. Some information was, however, provided by the Department of Industry. Typical usages stated were: steel 1/ FGU-KRONBERG/KU Gummersbach (Sector Study, Engineering Studies in Inidonesia). - 66 - wire manufacture - 27%, machine shops - 25%, electric cable manufacture - 50%, automotive assembly - 92%, and motorcycle assembly - 63%. The problem is, of course, closely related to the level of demand. The overwhelming opinion among many zenior executives with whom this question was discussed was that the problem centered on industry's failure - for a variety of rea- sons - to secure an adequate share of the market against foreign competition rather than over-capacity. Productivity Levels 8.19 Productivity also remains a cause for concern except in the newer, better-equipped firms. In 1973 a comparison among a wide-ranging sample of jobs done in Indonesia and the same type of work in Holland showed that the average time taken differed by a factor of six to one. Poor equipment and tooling, lack of work preparation and the use of oversize materials were found to be the main contributory reasons. 1/ It was not possible during the visit to check whether these findings were still relevant, but the mis- sion formed the opinion that productivity in heavy engineering was typically one-third to one-fifth that was found in European plants. 8.20 Several instances were noted where productivity in terms of physi- cal effort and skill compared favorably with European experience. Commenting on this aspect, a number of managers attributed it to the general employment situation and the scarcity of jobs. And there seems little doubt that this is an important factor. Management at one electronics factory which employs several hundred female workers stated that they had proved their staff could match the output levels achieved in other developing countries such as Korea and Taiwan, provided workflow was maintained. The latter, of course, depends on efficient management; that is one of the critical problems in trying to increase the indigenous staff. 8.21 Outside the new, more advanced industries, methods leave a great deal to be desired in terms of efficient production, and it is clear that substantial improvements could be made. The problems are well known and have been reported at length by different agencies, as indeed, have their remedies. But the inescapable fact remains that productivity in many areas of industry is seriously impaired by poor methods, equipment, tooling, etc., so that much of Indonesia's so-called comparative advantage in terms of low wage rates is largely if not totally eroded. Typical examples noted during the visit were: - a general lack of suitable handling and lifting equipment in the small/medium size companies. Dirt floors are common; overhead hoists or cranes are found only in the larger factories; - badly laid-out and congested shops with too much work being done on the floor instead of on benches; 1/ Bandung Institute of Technology with Dutch technical assistance. - 67 - - poor metal-removal rates. Much of the machinery unsuit- able, in a bad state of repair or outdated. There are still large numbers of pre-war, belt-driven machine tools in operation; little modern tooling; the frequent use of oversize or poor-quality imported materials. Because of time constraints and other fac- tors, many of the smaller firms obtain their require- ments through local markets where the range of sizes is restricted and the control of material specifications. often totally inadequate. 8.22 Fortunately, the picture is not wholly black. One of the encourag- ing findings from visits3 to different factories was the remarkable ingenuity exercised on the part of some firms in adapting little-used machinery or making special purpose eaquipment. To meet the delivery and quality require- ments of a contract to supply thin pre-formed stainless steel panels for a new mosque, one company had designed and made its own set of powered rolls to shape the intricate sections that were needed. Another small i-irm had built its own stamping machinery and also a simple low-cost wire forraing machine to manufacture fencing. But perhaps the most important development that has taken place has been the setting up of formal production/indusirial engineer- ing departments in some of the bigger firms. This has led to increased atten- tion being given to method specification and improvement, and ensuring the shop-floor is made aware of the way in which jobs should be done. Examples of the useful progress being made in this area were seen during visits to the machine shops of two large engineering concerns in Surabaya. In line with best modern practice, information on the equipment and tooling reuired, machine settings and sequence of operations to be followed to complete each job is set out on detailed method sheets given to the operator. Optimum speeds and feeds are adjusted to take account of machine tool condition, available tooling, etc; standard times determined by study and including a bonus element where required are also specified. 8.23 In cost terms, no advantage is gained from improved labor produc- tivity or methods of working if the net result is simply to increase the level of non-productive time. Conversely, significant improvements in output and hence lower operating costs can be achieved by reducing the nonproductive or idle time of the key resource - machine or manpower. Thus utilization is an important aspect of productivity. The main factors here are (i) workload, which tlepends ultimately on sales, and (ii) work-flow, which can be improved by better production p]anning and control. Progress has clearly been made in these areas since the previous visit, particularly by some of the bigger firms. The need for a separate marketing function is now more widely ac- cepted, and greater importance is attached to the need for effective controls in the manufacturing area. The contribution made by the Metal Industries Development Centre (MIDC) at Bandung both in training and in a consultancy capacity in these fields is to be commended. - 68 - Product Standards and Quality Aspects 8.24 Two aspects of technical performance which continue to be frequent subjects for discussion are standardization and quality. Taking standardi- zation first, the problem here is essentially external in that there is a large measure of agreement on standards amongst producers but still a wide divergence on the part of certain major consumers especially in the public sector. Sometimes difficulties arise because of differences in interna- tional standards. On other occasions problems are caused by wide variations in technical requirements for similar products specified by different users. These can be particularly acute in the case of certain volume producers such as electronics and cable manufacturers. 8.25 The problem is currently being tackled on an industry-by-industry basis through the various manufacturers' associations by MIDC. Despite Government backing it is doubtful whether real progress can be made without directly involving the various ministries and other public bodies concerned. This might be difficult to arrange for administrative, commercial and other reasons, and some other approach may be needed. One alternative which might prove acceptable to the interested parties would be to set up an independent Standards Institute, on which manufacturers, customers in both the public and private sectors, universities and other technical interests would be fully represented. This would necessarily comprise several groups, for example: materials, mechanical, electrical, electronics, instrumentation, etc., with cross links through the various operating committees that would be needed. 8.26 There is, of course, a close relationship between standards and quality in an engineering context. Inadequate or over-exacting standards can result in inferior goods being made on the one hand or excessive costs arising on the other, both of which lead to problems in marketing. Much of the improvement is due to investment in new plant and equipment, better training, and the installation of more effective controls. One of the difficulties now facing some companies is that of convincing their customers that the quality and reliability of Indonesian products are equal to those of most foreign competitors. This is clearly a difficult problem and one which could take several years to overcome. Market Factors 8.27 As already stated, the new consumer-based industries are expanding at a faster rate than their counterparts in heavy engineering. The reaons for this and possible steps to promote more even growth were discussed at length with senior officials and company executives. Indeed, more time was spent on this topic than on any other aspect. Whilst various internal weak- nesses have undoubtedly tended to limit output in the metal products and mechanical machinery industries, it is clear that 'lack of sales' rather than problems in the production areas has been the major cause of this situation. The ability of a company or an industry to compete successfully in the market place depends on many factors. These are often complex and frequently inter- act one with another. - 69 - The Type of the Market 8.28 The market for capital goods in Indonesia is dominated by large- scale public sector programs to develop the country's economy. Much of the finance for this type of investment is obtained through foreign governments, with the donor countrie.s often providing hardware and know-how as integral parts of an aid package. Thus, apart from some local building construction and other site work, domestic industry is often precluded from the manufac- ture of any plant and equipment required, regardless of technical capability, price, or other considerations. 8.29 Major projects are also financed by international banks and other agencies. The supply of plant and machinery in these cases is usually sub- ject to competitive tender, and is therefore open to domestic as well as foreign manufacturers. Although some degree of preference is usually given to Indonesian industry - 15% on capital equipment in projects funded by the World Bank, for example - overseas companies are also favorably dealt with in that their equipment is exempt from import duties and other ta.xes. Another form of public sector project is one in which the funding is largely or wholly sourced internally. In this instance, local industry does not receive any preferential financial treatment. Foreign-made equipment, on the other hand is still exempt from duty and taxes. 8.30 Price, of course, is not the only factor which detennines a sale. For example, one design of machine may be unable to meet the specified re- quirements or perhaps running costs are too high in comparison with another manufacturer's product. Quality and reliability are other obvious, important considerations. There is a widely-held view among Indonesian producers that sales are lost to imports because the officials concerned with public sector programs wrongly believe that local products must be inferior. Although it would be difficult to prove or disprove this assertion, the implications are such that further investigation would almost certainly prove worthwhile what- ever the outcome. Domestic Marketing 8.31 From discussions with various firms, there appears to be some com- petition among domestic producers, especially amongst the larger privately- owned companies. At the same time, there is increasing collaboration between them through their respective trade associations, and quasi-cartel arrange- ments are beginning to emerge. Perhaps, not surprisingly, the electronics and automotive firms have led the way in building up selling organizations to develop their markets. There is little doubt that this is due to the influence of the overseas companies and their managers involved in setting up these new businesses. 8.32 There is, however, still a general lack of marketing effort by the smaller firms that typically rely on taking orders from a few regular customers instead of going out to sell new business. As a result, oppor- tunitiEs are lost and expansion is stifled through a failure to compete. - 70 - MIDC is conscious of the problems faced by this type of company which often has very limited resources and whose markets tend to be confined to nearby geographical areas. Professional assistance is currently being given to three such firms in the Bandung area on a pilot-study basis to improve their effectiveness in marketing, product design and manufacturing. The scheme is planned to be extended to other engineering companies during 1977. Imports and the Ability to Compete 8.33 The main competition in the engineering sector comes from abroad in the shape of imports. In 1975 the value of engineering products (excluding the automotive categories) imported during 1975 was Rp 625 billion (US$1,505 million) more than four times greater than the combined output from Indonesian manufacturers in value added terms. This is based on the estimates shown in Table 8.5. The ratio has doubled since 1972 when the corresponding imports totalled Rp 196 billion. 1/ At that time, the greatest imbalance was found in the mechanical machinery product group where the volume of imports was seven times that of domestic production. As Chapter III shows, in 1971 in the "machinery" industry only 5% of total supplies were domestically produced. Unfortunately, it was not possible to make up-to-date comparisons of imports and production levels in this particular category because of the lack of data. But the available evidence suggests that the situation has probably changed very little in the interim. 8.34 Various measures have been taken to contain imports. In certain instances a total ban on imports has been instituted, namely passenger cars and commercial vehicles other than C.K.D. units, galvanized iron sheets, and road rollers (6-12 tons). In other cases, varying levels of duties and import sales taxes have been applied. Some examples of these are given in Table 8.6. Part of the import total can be accounted for by the high propor- tion of foreign produced materials and components used by local manufacturers. This applies not only to the assembly-based automotive and electronic indus- tries, but also to the metal products and machinery groups though to a lesser extent. Typical requirements are: Raw Materials Wire rod, steel forgings, hot and cold rolled steel sheet, steel plate and sections, aluminum plate, copper wire and rods. Components Diesel engines, fasteners, instruments, and parts for the automotive and electronics industries. With very few exceptions, import duties and taxes have to paid for materials or components procured from abroad. These can result in significant addi- tions to product costs and, in turn, adversely affect prices. 1/ FGU-Kronberg/KU Gummersbach. Table 8-5 | 'fl'V Z-.* -^^ ^ A:sjs s £S £. -uuLu id_ LAvu llg .Ly t Value Added Value Added Domestic Imports Content of Imports Production $ Million Rp Billion Rp Billion Rp Billion Metal Products 122 72 27 Mechanical Machinery and Equipment 824 342 137 Electrical Machines, Electronics, etc. 396 164 66 28 Transport Equipment 13 47 19 1,505 625 249 53 Notes: 1. - Individual figures are rounded 2. Value added coefficients of 0.37 and 0.40 respectively were used to calculate the value added content of imports. 3. Estimates of domestic production taken from Table 1 adjusted to small-scale and cottage industries output. Source: CBS, Import 1975. - 72 - Table 8.6 INDONESIA: Import Duties and Taxes for Various -Engineering Materials and Products Item Dutr Import Sales Tax -- -- -- -- -- -- - -- %- -- -- -- -- -- - Steel billets/scrap 5 5 Steel wire/pipes 40 15 Aluminum sheet 5 5 Aluminum extrusions 55 15 Diesel engines 30 10 Water Pumps 30 10 Hullers 40 10 Sewing machines 70 10 Copper wire 5 5 Cable 60 10 Refrigerator/air conditioners 60 (built up) 20 (built up) it " "30 (CKD) 10 (CKD) Automobiles 100 (CKD) 20 (CKD) Commercial vehicles Motorcycles 30 (CKD) 10 (CKD) 8.35 It is widely believed that, because wages are low in comparison to other countries, Indonesian manufacturers ought to be able to compete successfully against foreign producers. Whilst there are, indeed, instances where this is true, this is demonstrably not the general case. The fact is that the wage cost advantage is more than offset by a variety of other fac- tors including: inadequate and poorly maintained equipment; poorly trained labor in many industries which leads to low productivity; uncertain market demand leading to poor work scheduling; dependence on imported inputs whose costs include duties and excise taxes; and weak marketing organizations which in turn reflect back on production scheduling. These are all interrelated factors. 8.36 Accurate price comparison, which are also representative, between locally-made and imported products are difficult to make without undertaking a fully detailed survey. 1/ There are also considerable differences in 1/ The Germany Study Team made a detailed analysis of 21 engineering firms and 23 workshops in 1973, but were only able to make direct comparisons of prices with imported products in a few instances. Generally, heavy engineering products were considerably more expensive than imports. Domestic appliances were relatively competitive. - 73 - import charges and taxation as has been shown. At one end of the scale, some electronic components are made as cheaply as anywhere in the world. At the same time, automobiles cost three times the C&F equivalent because of uneco- nomic production rates and high taxation levels. From the data available, heavy engineering products as a group are estimated to cost between 25% and 60% more than their imported counterparts. It will require a concentrated development program to improve the competitive position in these industries .Major Constraints on Development 8.37 In addition to current problems, considerable attention was given to the key factors likely to inhibit further growth in the engineering industry. Although there were differences in emphasis, a surprisingly wide measure of agreement was found between those who took part in the various discussions on this important aspect. The factors can be grouped together under two main classifications, internal and external. The internal category covers the kind of problem which can be tackled'to some extent by an individual firm provided, of course, it has or can be given the necessary resources. External factors, on the other hand, concern the wider issues facing industry over which it has little or no control. These are discussed in turn below. Internal Factors 8.38 Apart from a widespread need to overhaul or replace machine tools and other plant in many firms, the main internal problem facing industry concerns the continuing lack of key people. This covers both skilled produc- tion wcrkers and the technical and managerial staff. Considerable efforts have been made to deal with this problem by expanding and uprating training facilities and programs. In the case of skilled workers, extensive use has been made of the Regional Training Centers and other bodies such as MIDC, along with in-plant training. One large engineering company has spent some Rp 4.5 million on training 500 machine operators and welders during 1976 as part; of a long-term plan to ensure it has the skills iL needs. This has proved a successful form of investment so far as this firm is concerned. 8.39 Although the supply of skilled labor has undoubtedly increased, there is still an underlying shortage. This is evident from the frequent complaints of 'hi-jacking' from the larger firms by companies unable or unwilling to train their own staff, and is reflected in the high rates of pay that are offered. At one end of'the scale, unskilled laborers and helpers receive a minimum of around Rp 12,500 per month excluding overtime and other cash payments. This compares with gross earnings of Rp 50,000 to Rp 100,000 a month quoted for top-skilled welders and other engineering grades. These figures were obtained partly from official sources and partly from companies visited. In most instances the variation between the lowest and highest earnings within a single company was of the order 2.5 to 1. In one case it was as much as 5 to 1. It would also appear that differentials have widened over the last five years or so in contrast to the reverse trend in other countries. - 74 - 8.40 Substantial fringe benefits are also paid to induce workers to stay with their employers. These include family allowances, transport to-and-from work, free meals, overalls, medical care, and, in some instances, accomodation. Special bonuses of one month's wages or more are paid at the 'Idul Fitri' day or Christmas holiday as appropriate. Long service awards may also be given. The value of these benefits varies from firm to firm. In terms of production costs, they can add some 15-25% to the labor cost. 8.41 The availability of good technical and managerial staff remains a problem in the industry. The salary levels offered to newly qualified graduates, Rp 100,000 and higher per month, reflect their scarcity value. Extensive and costly industrial training is also necessary for these men, much of it abroad, because of their lack of practical experience at univer- sity. There is particular difficulty in finding suitable men for design and production engineering work because of the time it takes to acquire the necessary depth of knowledge and experience. As a result, many engineering companies lack the technical staff to adapt or extend their product ranges themselves. Similarly, only limited effort is devoted to the major task of improving production methods and efficiency in the heavy engineering areas. External Factors 8.42 There is almost universal agreement that the lack of funds at reasonable terms is restricting the growth of the engineering industry in Indonesia. Some private firms have extreme difficulty obtaining any money for expansion, others are forced to limit their borrowing because of the high interest rates that have to be paid. As a result, long-term develop- ment is very largely dependent on short-term profitability. A director of one small firm was justifiably proud of the fact that they were able to finance expansion, albeit slowly, out of trading profits. He was doubtful whether many others could make a similar claim and was generally worried about the industry's future. Interest rates are currently 18% per annum for investment capital, and 24% for working capital. The problem is accen- tuated where debt/equity ratios are high, as in the case of certain state- owned enterprises which were found to have ratios greater than nine to one. 8.43 In the capital goods sector, competition from imported products is regarded as the biggest single factor limiting expansion. This is blamed for the heavy underutilization of plant and the consequent loss of employ- ent opportunities. A good deal of criticism is levelled at the duty and tax exemption given to foreign suppliers. There is also concern at the apparent unwillingness of some public bodies to specify machinery and equip- ment made by Indonesian firms, even where this is cheaper and manufactured to the required international standards. Although there is no doubt that the market for heavy engineering products has been badly distorted by the level of imports, no one seems able to quantify this in meaningful terms. There is, of course, no shortage of specific examples where local firms have failed to secure contracts against foreign competition. But much more infor- mation would appear to be needed to prepare a case convincing enough to bring about any desirable changes in policy. - 75 - 8.44 Day-to-day operations and the development of new ventures in the engineering industry are both badly affected by the unnecessary delays that occur in. dealing with various public authorities. The excessive time re- quired t.o obtain customs clearance for production materials imported by sea, for exaniple, can result in significant 'hidden' costs with multiple payments required in order to get official approvals. In one instance t'his involved 84 checkpoints, and 10 signatures were required before a consignment was released.. By contrast, items sent by air freight are processed with very little delay. Problems frequently arise in the interpretation of tariff rates. Duties on items not specifically listed are often set at arbitrary high levels, which are seldom challenged to avoid even more delays and consequent costs. Problems also occur when exporting. In general, little incentive is given to the industry to export and, in many respects, there appear t:o be positive disincentives. In particular, the time taken to recover duties paid on imported materials and components subsequently re- exported in finished product form is almost absurd in comparison with the situation found elsewhere. Delays of twelve months are common; drawback took three years in the case of one electronics company. If the engineering sector :Ls to become export-minded - an essential long-term requirement for an efficient industry - considerable changes are clearly going to be needed in this area. Future Trends and Prolect Identification 8.45 Although a gocid deal of attention was necessarily directed towards the present-day problems of the engineering industry, the mission was primar- ily concerned with development needs. Particular consideration was given to assessing the broad reqtuirements five to eight years ahead to improve and expand this important sector, and to identifying possible projects or invest- ment oplportunities of a type compatible with this program. This section of the report considers those aspects, looking first at the question of overall strategy. Particular emiphasis is given here to important areas of uncertainty which need to be taken i;nto account. The Need for an Overall Strategy 8.46 A comprehensive ten-year strategy to develop Indonesia's engineer- ing industry was set out: earlier. This was based on the manufacture of key products mainly for the public sector, with priority given to t:he following areas: - agricultural equipment - construction equipment - trucks and buoes - industrial electrical equipment -76- - railcars - ships. Light engineering products such as bicycles, sewing machines and home ap- pliances were excluded from the list because of their capacity for develop- ment under private initiative and what was considered to be their relatively small effect on industrialization. Preference was given to the manufacture of commercial vehicles as opposed to passenger cars, because of the enormous difficulties in achieving economic car production with the profusion of makes that existed. 8.47 The development of primary and intermediate products, or 'build- ing blocks' to promote a balanced industrial base formed an integral part of the strategy. Examples of some of the principal components and subas- semblies which were identified are shown in the flow chart re-produced in Figure 1. A three-stage program was envisaged comprising: Stage 1 - Expansion of existing industries (e.g, trucks and buses) and the manufacture of new products (construction equipment, power transmissions, electrical products). Also, the reorganizaton of the foundry industry, rehabiliation of the shipyards and the development of a forging capability. Stage 2 - Expansion of construction equipment manufacture with production of farm tractors to be added. Expansion of foundry output with the addition of steel and non-ferrous casting capabilities, and the setting up of a stamping industry. Re- organization of the automobile industry. Also, the building of oceangoing ships. Stage 3 - Establishment of precision component production, also machine tools. Development of four large- scale manufacturing complexes for motor vehicles, other mobile equipment, stationary machinery and ships. 8.48 Although some progress in this direction has clearly been made, the timescale estimated in 1971 has proved to be overoptimistic. With some notable exceptions (the development of construction equipment is one example) Stage I can be said to be largely complete. However, few of the projects envisaged in Stage 2 have so far materialized. Local component manufacture is held back by the lack of stamping and forging facilities. Indeed, many of the projects which formed part of the original strategy are unlikely to be completed until the mid-1980s or later. RAW PRIMARY PRIMARY GENERAL SPECIAL END MATgRIALS CONVERSIONS COMPONENTS SUB-X i kBLIES SUB-ASSEMBLIES PRODUCTS Steel Mill* Foundry Fasteners Boilers Structures Agricultural Products rLOUUUCL tanks, etc. Equipment Special Forgings Bearings Transmissions Parts for Pro- Construction* Alloy Steel cessing Mills Equipment Foundry Stampings Transmission Pumps & * Industrial Trucks, Buses r Pig Iron Components Cotpr,ess&rs Hardware" _ Non-Ferrous Valves, etc. Hydraulic Accessory 'Electttcal* . Material Devices Equipment Equipment r H Engines* Brake Ships H Systems __o Electrical* Suspension Railcars Components Systems Control Systems Deck Machinery Note: Products underlined designate sectors where there was a significant activity or capability in 1971. Areas where substantial development has subsequently taken place are marked with an asterisk. - 78 - 8.49 A different approach was adopted by the FGU-Kronberg/KU Gummersbach Group in a major study of the engineering sector in 1973. The study did not attempt to define a comprehensive strategy or framework for the development of the industry. Instead, more emphasis was given to the development of finished products. It covered both consumer and capital goods industries; a large number of possible projects was identified using import substitution as a starting point of the selection process. In the supply areas, feasibility studies were undertaken of plastic mould manufacture, the production of machine cutting tools, and the production of carbide metals. The rehabilitation of machine tools and measures to improve the efficiency of a number of existing enterprises were also studied. 8.50 Having considered the problems of Indonesia's engineering industry at length for a second time, the mission is convinced that the need for an overall strategy is as important as ever. This should cover the whole sub- sector, from the manufacture of raw materials and components through to finished products. It should also include consumer items as well as capital goods and make provision for the small-scale industries. There are obvious advantages for developing such a strategy as opposed to a piecemeal approach. For instance: - industrial planning would be facilitated; the relevant part of the strategy could be incorporated into Repelita III. - uneconomic use of scarce resources, particularly local funds and talents, would be minimized. - technology transfer would be achieved more cohesively and rapidly. - a broad-based, more efficiently managed industry would result which should attract much higher overseas invest- ment. 8.51 The thinking behind the ten-year plan referred to above is still valid, and could be readily adapted to the current situation. The matrix of building block products would, of course, need to be modified as would timing. There are, however, a number of factors which need to be taken into account before a revised strategy can be determined in other than general terms. For example, action is required to deal with the problems of heavy engineering which are holding back development in this key area. Also, the fragmentation of automobile assembly is affecting the growth of component manufacture. The longer-term possibility of exporting selected products is also a relevant question. Each of these is discussed more fully below. Areas of Uncertainty 8.52 Some of the changes that have occurred in the engineering subsec- tor since the date of the previous visit could have an important bearing on - 79 - the industry's future development. The comparatively explosive growth in electronics is a case in point. This has created new employment:, involved new technology, and established a thriving business. There are signs, though, that the rate of expansion in this area will be less dramatic over the next five years unlesss some stimulus is given. 8.53 In the metal products and engineering machinery areas, the failure of domestic industry to secure a bigger share of the capital goods market is clearly a cause for concern. Underutilization of capacity is widespread, even amongst the newer companies. Indeed, some of these could founder if present levels of production are not increased. With trading al: or near break-even point, many firms are unable to generate sufficient funds to finance future growth. 'Whilst the reasons for this situation are known well enough, the full extent of the problem is not. The industry has no doubt that the problem is serious, but cannot begin to answer such ques- tions as: - what proportion of the market is accounted for by imports which have no Indonesian equivalents? - of the remainder, what is the proportion of imports? - how much of this is tied to foreign investment which might otherwise be lost? - how much is exempt from import duties and sales taxes? - how much potential business is lost because no one is aware of a requirement or responds to the inquiry? 8.54 The automotive industry has also expanded rapidly over the last five yecrs. However, this has been achieved at the expense of much needed rationalization, by allowing too many firms to establish local assembly operations. By 1975, the number of assemblers had increased to 18. A year later this had risen to 28 firms who, between them, produced 23 makes of car and 27 makes of commercial vehicle. As a result production rates are grossly uneconomic. In 1974 the cost of assembling small- and medium-size passenger cars was approximately equal to the landed cost of CKD components after the payment of all import duties and taxes. 1/ Present day indications are that the ratio is close to 1.5 to 1 despite increased import tariffs. Not sur- prising]Ly, only limited progress has been made towards the local manufac- ture of components. Also, the plan to divert resources from car assembly to commercial vehicle manufacture has only been partially successful. 8.55 In an attempt to regulate the situation, the Department of Industry announced new curbs in June 1976. The numbers of makes of passenger cars and commaercial vehicles would be reduced to ten each by the end of 1984; no 1/ R.S). Sharma. Department of Industry Report on the Automobile Industry in Indonesia, May 1974. - 80 - new licenses would be issued for at least a year. At the same time, the import duty on C.K.D. commercial vehicles was abolished while the duty on C.K.D. sedans was doubled to 100%. The import sales tax and the tax on assembled cars were also increased from 10% to 20%. The Government's policy for this subsector, if successful, will have profound effect on the industry. However, the situation is so complicated that major difficulties are likely to arise unless the process is very carefully planned and managed. There could also be repercussions for the engineering industry in general. For these and other reasons, the special problems of the automotive industry are likely to become a critical element in any future development strategy. Areas for Further Investigation 8.56 It is clear from the above that, unless action is taken to deal with the special problems of the engineering industries, further progress will be seriously retarded for years to come. Unfortunately, it is not pos- sible at this stage to determine the precise action required in each area because of an almost total lack of data, but suggestions are given below. Review of the Market for Heavy Engineering Products 8.57 An in-depth study of the capital goods sector is urgently needed, to investigate the reasons for the present high levels of imports and to determine the scope for greater participation by domestic suppliers. The study should concentrate on the public authorities and state-owned corpora- tions which, collectively, are industry's main customers but should also include the private investment sector where appropriate. 8.58 In addition to answering questions on market trends, particular attention should be given to the effects of customs duties and exemptions, taxation and the like on price levels. Assuming the necessary cooperation could be obtained, the tenders submitted for a number of specific projects should be examined to determine the reasons for price variances. Ordering policies in the public sector should be carefully studied, especially the criteria used in the assessment of competitive quotations. The study should also cover problems of product quality and standardization, and probe atti- tudes towards locally made engineering products. The findings should quan- tify in detail the potential for increasing Indonesian manufacturers' share of the heavy engineering market, and set out the policy changes and other action that would be necessary to achieve this. Review of Longer-Term Prospects for Exporting Engineering Products 8.59 Essentially a marketing study, this review should determine the possible scope for exporting engineering products over the next decade. It should identify in broad terms: the markets offering the best potential for export sales, including possible opportunities in an ASEAN context; the structure of these markets; the types of product likely to be competitive; the probable competition in both qualitative and quantitative terms; possible problems in pricing, tariff barriers and other forms of protection. - 81 - 8.60 The review should also consider problems of overseas representation, distribution and necessary after-sales back-up. The question of incentives and other forms of assistance for the industry should also be examined. This would include, for example, waiving of export taxes, improving the draw-back arrangements on materials re-exported, streamlining documentation, and the provision of special credit facilities. The role that could be played by new offshore joint venture companies in the export field should be carefully assessed. This project should not take longer than the proposed study of the capital goods sector in terms of elapsed time as much of the basic fact-find- ing work could be done by desk research. Specific Project Possibilities 8.61 In addition to the broad-based studies described above, a number of possible development projects should merit early attention. These include some new ideas along with others previously canvassed. The list is based on observations and information obtained during the visits to engineering firms and other relevant data. Account has also been taken of the findings and recommendations made by the 1971 Mission and the 1973 German Study Team. The projects are grouped under two main headings: new products and service-based industries. Additionally, a possible program to tackle the problem of low productivity is discussed. New Products 8.62 The following group of products is considered well within the capabilities of the engineering industry, although extensive external de- sign artd manufacturing know-how would be necessary at the outset. Detailed studies; would, of course, need to be undertaken to establish the full market potential, manufacturing facilities required, probable viability, employment prospects, capital costs, etc. (a) Woodworking Machinery 8.63 Long-term development of the country's wood-based industries in such areas as sawmill products, pre-finished building materials including floorirLg and wall panelling, and furniture could create a substantial demand for woodworking machines of all types (see Chapter VI). Currently imports of this machinery are running at an annual rate of around US$3.6 million - three times that of 1971. The product range includes sawmill machinery, small and medium size circular saws, band saws, other woodworking machines. 8.64 The feasibility of manufacturing woodworking machinery was examined by the FGU-Kronberg/KU Gummersbach Group in 1973. They estimated that the market for sawmills and woodworking machinery would comprise 6,000 to 7,000 machines by 1979 based on an annual growth rate of 30%. While the manufacture could start as an assembly-based operation, a high proportion of domestically produced components should be possible within three years. Associated with this development, there should also be scope for other wood-processing equip- ment to be made in Indcnesia. Kiln driers are one example. The sophisticated control instrumentation these require would still need to be imported. - 82 - (b) Agricultural Machinery 8.65 The continued emphasis on agricultural development in Repelita II has led to an increased demand for agricultural machinery and related products. Excluding tractors, imports of this equipment are likely to total more than $3 million in 1976. An interesting development in this area is the attention now being given to crop diversification outside the island of Java. This could lead to a requirement for a wide range of light agricultural equipment very different from the machinery currently produced in Indonesia for rice and sugar processing plants. There may also be the possibility of export business later on. Relevant data is, however, not available. Because of the undoubted long-term potential in this area, a full-scale study should be undertaken. (c) Construction Equipment 8.66 Infrastructure is another major development area which has resulted in large investments in machinery and equipment. During 1976 bulldozers, mechanical shovels and excavators and levelling and tamping machines were being imported at the rate of US$95 million per annum. Dumper trucks imports were likely to be worth an additional $40 million. One project to make the heavier type of equipment is being considered by P.T. Barata who already manufacture road rollers. They are currently looking for a suitable overseas partner for a joint venture operation. With the wide range of construction equipment that is used, there should also be scope for other manufacturers - particularly in the lighter, more specialized equipment which includes, for example, tractor-based equipment, small rollers and levellers, and dumper trucks. (d) Materials Handling Equipment 8.67 Requirements for this type of equipment go hand in hand with indus- trialization. The range of products is considerable and covers, for example, overhead travelling cranes and hoists, tower cranes, mobile cranes, screw conveyors and other bulk handling equipment, roller conveyors, warehousing and storage equipment including racking. There are also several marine appli- cations such as winches and deck cranes. It is difficult to obtain a detailed breakdown of imports but the category which includes cranes accounted for $38 million in the year up to August 1976. In the case of overhead cranes and hoists, a project has already been submitted to the authorities for approval. Three other product groups could also provide substantial scope for develop- ment, namely: conveyor systems, warehousing and storage equipment and desk handling equipment. (e) Valves 8.68 Although several types of pumps are made in Indonesia, very few valves for pipeline and other applications are manufactured locally. This is surprising as valve bodies and pump casings are often similar in design and require the same production processes, whereas the moving parts of a valve - 83 - are generally much simpler than a rotating pump impeller. In terms of imports, valves currently account for some US$14 million per annum - 40% of that for pumps. There is, of course, a wide range of applications and designs, depending on flow rates, pressures, and the liquids involved. With the hi.gh rate of investment in two public sector areas, namely oil produc- tion and distribution, and irrigation systems, the manufacture of valves appear to be an area of investment opportunity that has been overlooked. From the point of view of linkages, the main components are caLstings and would provide additional outlets for cast-iron, steel, and non-ferrous foundries. 'f) Specialist Vehicle Manufacture 8.69 With bus and truck assembly now well established, there is scope for extending the product range by adding specialized body-building and vehic:Le manufacture. The range of products envisaged included: mobile airport equipment such as transporters, loaders, recovery vehicles, and crash tenders, etc,; refrigerated vans and trailers; refuse and sewage collection vehicLes. Unfortunately statistics are difficult to obtain fcr the whole range. Some indication of demand is given, however, by the current import data for road-sweeper trucks. In 1976, imports in this category were averag- ing US$15 million on a. yearly basis. (g) Small Petrol. and Diesel Engines 8.70 The possibility of manufacturing a range of small engines for the home market has previously been examined. Typical applications include: semi-Submersible and cither pumps; small standby generating sets, air compres- sors, and machine tools and other equipment. Inboard and outboard motors for small boats are additional possibilities. A production rate of some 5,000 units a year was envisaged in the project studied by the FGU-KRONBERG/KU Gummersbach Group in 1973, on the basis of domestic consumption. The poten- tial for exporting was not considered, but could add significantly to the market, especially in the longer term. 8.71 The list of projects could well be extended to include the manufac- ture of light electrical equipment (transformers, circuit breakers, electric motors, etc.) for the utility and other industries, as well as a greatly expanded shipbuilding and repair activities. It is clear that even for the somewlhat limited number of product groups described above, development pri- orities would need to be established within each group covering not only the items identified but also the related components that could bes locally manu- factured. In additiort, the present system of incentives may require modifica- tion to encourage existing Indonesian firms to participate in these projects. Service-Based Industries 8.72 The requiremlent for engineering spares and service back-up has changed in line with the changes in technology that have occurred in recent years. As a result, new opportunities for investment in this field are now becoming apparent. The following three areas are considered to offer par- ticular opportunities in this connection. - 84 - (a) Textile Machinery Spares 8.73 Although detailed statistics are difficult to obtain, it is clear that there is a substantial demand for textile machinery spares. There are a number of firms that can make some of the items required but a high propor- tion of the parts still have to be imported. Although some precision machine- ry is called for, the work is well within the capability of many firms except in one respect. There is a significant lack of gear cutting and grinding facilities to cover the wide range of spare gears that are needed. A small production unit initially is envisaged producing spur, helical and other types of gearing which should provide a very useful service to the textile industry. The machine tools required include: hobbers, gear shapers, lathes, internal and external grinders, and a key-seater. Heat treatment and hardening facilities would also be needed. 8.74 In addition to textile spares, there is likely to be a considerable demand for gears from other industries. Production quantities would, however, be small, and could not be mixed with the manufacture of high volumes of gearing for, say, automotive industries. Ideally, such a venture should be undertaken with an existing medium-sized engineering firm which has reasonably up-to-date machine shops. Further study would, of course, be needed to establish the viability and probable costs involved. (b) Machine Tool Rehabilitation 8.75 Reference has been made earlier to the problem of out-dated and poorly maintained machinery. Although some progress is being made at last with the center established by P.T. Barata, it is clear that this will only partly solve the problem. Additional facilities are likely to be needed if many of the older medium- and smaller-sized engineering firms are to become efficient. The feasibility of constructing a second rehabiliatation workshop was examined by the German Study Team in 1973. They concluded that a center capable of overhauling 200-250 machine tools a year was justifiable provided also there was a long-term aim both to manufacture spare parts and to build new machines. (c) Electrical Re-winds 8.76 There is likely to be a growing requirement for a repair capability in the electrical area. Motor re-winds is one such example. This is a specialized operation but one involving less technical know-how and capital equipment than that required for original manufacture. Although similar in many respects, it would differ from a machine tool overhaul facility in one key aspect - the need to offer a very fast service. It could be coupled with an agency for selling spares and new equipment, and possibly also form part of a broader-based electrical contracting business involving site wiring and other installation work. Productivity Improvement 8.77 Low productivity is holding back progress in a number of areas, particularly among some of the older mechanical engineering companies. As - 85 - already stated, MIDC has begun to make a significant contribution in this directicn but much more needs to be done if industry is to become efficient, especially in the context of import competition. MIDC is active in two important areas here. Firstly, it provides training in management techniques and controls. And secondly, it offers a consulting service to industry. The lack of staff and funds, however, largely restricts their present field of operations to the Bandung area. 8.78 The MIDC approach is proving to be very successful and in the view of the mission, deserves to ½_ extended. This could be accomplished in two ways, by expanding the present facilities, or by setting up separate centers in other key locations such as Jakarta, Surabaya and Jogyakarta. The first of these alternatives has obvious advantages in that it would be based on an organization that is already operating effectively. Of course, it would need to establish branches in the other main industrial centers, but could continue to use Banoung as a central training facility. SUMMARY AND CONCLUSIONS 8.79 In the five-year interval since the visit by the previous mission, the engineering industries have more than doubled in size and become wider- based and generally more efficient. However, comparisons of different industries within the subsector indicate that this development has taken place unevenly. In the consumer-based product areas the electronics and automotive industries have expanded rapidly over the period both in terms of outptut and employment, and are still expanding, though not always in an efficient way. The heavy engineering industries have expanded but excess capacity is widespread and there is currently little growth. 8.80 The main causes of this apparent imbalance are: Internal. Difficulties - low productivity and poor, out-dated machinery and equipment; - shortage of skilled manpower and the lack of technical and managerial talent. External. Problems - difficulties in obtaining finance at reasonable terms; - heavy additional costs which offset any comparative advantage from low wage rates; - preference given to imported products in the capital goods sector. - 86 - The external problems are particularly important. And, if present policies remain unchanged these are likely to retard further development of the sub- sector especially in the heavy engineering areas. 8.81 Looking ahead, the mission is convinced of the need to have an overall strategy for developing Indonesia's engineering industries as a whole. Although the broad guidelines set out in the 1971 report are generally still valid, these need to be revised and updated to take account of the changes since 1971 and the factors likely to inhibit progress. Two major studies are recommended in this connection to assess possible measures to deal with key problem areas and assist the development of an effective industrial strategy. These are: (1) an in-depth study of the problems in the capital goods sector; and (2) a study of the possibility of developing a strong export business. 8.82 Project areas suggested for early attention include: (a) New Products: woodworking machinery; agricultural ma- chinery; construction equipment; materials handling equipment; valves; specialist vehicles; small petrol and diesel engines. (b) Service-based Industries: textile, machinery spares; machine tool rehabilitation; electrical motor rewinds. (c) Productivity Improvement: extension of MIDC, linked to a new scheme to train graduate engineers. 8.83 Progress has been achieved so far despite many difficulties and constraining factors. Opportunities for further expansion also look promis- ing, but there is a need to have an effective strategy and program of action to guide the development of this important subsector of manufacturing indus- try through the 1980s. - 87 - IX. THE TEXTILE INDUSTRY Current Status of the Industry 9.01 The textile industry has been growing considerably in recent years. Its share in total industrial value added was 11% in 1970 and rose to 17% in 1973. In 1969 the output of knitting and weaving was 450 million meters and increased by 141% to 1,085 million meters in 1975/76. The number of spindles increased from around 482,000 in 1969 to 1,152,000 in 1975/76. This increase in capacity was also accompanied by an increase in productivity. The output per spindlle was .07 MT p.a. in 1969, and .10 ton p.a. in 1976. The total capacity of dyeing, finishing and printing amounted to 665 million meters in 1970 and the actual output was 933 million meters in 1975/76. All non-cotton fiber was imported in 1969, but in 1975/76 there were four synthetic fiber making units with capacity totalling 59,000 MT per annum. The growth was also accompanied by the production of new products such as blended and tex- turized yarn, suiting and shirting, tricot double knit, embroidery, brocade, and laces. Weaving 9.02 The weaving industry grew rapidly during 1969 - 1975/76. The number of power looms increased from around 35,000 in 1969 to around 60,000 in 1975/76 as can be seen in Table 9.1. Total output (excluding knit goods) more tharL doubled from around 372 million meters in 1969 to around 877 mil- lion meters in 1975/76. And capacity also doubled from around 682 million meters in 1969 to around 1,637 million meters in 1975/76. This increase in capacity and output was one of the main programs in Repelita I and continued in Repelita II. 9.03 The Directorate General of the Textile Industry (Ditjentek) defines a weaving; unit with hand looms, or 100 or less power looms as small scale. By this definition 81.5% of the existing mills in 1975/76 and 40.6% of power looms belong to small scale. The average size of weaving mill is 78 power looms. 9.04 As regards locational distribution, most of these weaving mills are located in Java, particularly in West Java. The data in Table 9.3 shows that 94.2% of the mills, 96.8% of the power looms and 97% of the output were located in Java. Only a very small part is located in other islands. Out of the total in Indonesia, 65.0% of the mills, 56.3% of the loom3, and 58.4% of the output were in West Java. These figures also show that the size of the mills on the average in West Java is smaller than in the rest of Java or Indonesia as a whole. - 88 - Table 9.1 The Weaving Industry 1969 1973 1975/76 Power looms (000) 35 50 60 Handlooms (000) 166 50 69 /4 Total output (m. meters) 372 769 877 /1 Output per looms: Power looms (000 meters) 6.54 /2 - 13.62 Handloom (000 meters) .87 /2 - .87 Capacity: Powerlooms (m. meters) 420 1000 Handlooms (m. meters) 262 75 7 - /1 Consist of 816 m. meters of power looms and 60 m. meters of hand looms. /2 Estimated. /3 Calculated from Repelita II for 1977/78 and 1978/79. /4 The numbers shown are those registered and may not be in operation. Source: The 1969 and 1973 figures are basically from Ditjentek: "Pola Pembangunan Industri Tekstil Repelita Tahap II" and Draft of R.G. David: "Notes on Textile Subsectors". The figures for 1973 are targets, except the total output figure is the realized figure taken from CAFI No. 621, Oct. 1976 less the estimate of knitting output. The 1975/76 figures are from the Feb. 1976 census of Ditjentek. Table 9.2 Distribution of Power Looms in 1975/76 Size Mills Looms (No. of Looms) Number Percentage Number Percentage 0-100 630 81.5 24,500 40.6 101 or more 143 18.5 35,872 59.4 Total 773 100.0 60,372 100.0 Source: February 1976 Census of Ditjentek. - 89 - Table 9.3 Locatic,nal Distribution of Weaving Mills Mills Power looms Output Number , Number % (000 meter) % Java 727 94.2 58,459 96.8 792,200 97.0 DKI 27 3.5 3,456 5.8 63,621 7.8 West 503 65.0 33,974 56.3 470,802 58.4 Central 136 17.6 13,577 22.5 158,811 19.4 DIY 19 2.5 1,735 2.9 30,681 3.8 East 43 5.6 5,711 9.5 68,283 8.4 Others 46 5.8 1,913 3.2 24,859 3.0 Total 773 100.0 60,372 100.0 817,057 100.0 Source: February 1976 Census of Ditjentek. 9.05 There have been some significant changes in employment as a result of the increase in power looms and a decline in the number of hand looms. The additional power looms during 1969 - 1975/76 were around 25,000. Taking 1.1 as the ratio of workers per loom, the labor force absorbed would be around 27,500. The number of hand looms dropped to 69,000 in 1975/76 from 166,000 in 1969. If 1.3 is taken as the ratio of workers per hand loom, this means that around 126,10C0 workers lost employment as a result of the displace- ment of hand looms by power looms located in larger-sized units. 1/ 9.06 The displacement took place in 1969 to 1973; after that the small and large mills specialized in different products. After 1973 the small mills specialized in products such as sarung, singket and other traditional products. Thus it seems likely that no further sharp decrease in hand looms will occur. 9.07 As has been indicated, a significant part of the weaving industry is in the hands of small enterprises. They suffer from many disabilities, compared to the larger units, including low productivity per loom or per worker, difficult access to credit, lacking production planning and control, and in other management aspects. Also, all the weaving industry has had to contend with competition from cloth illegally smuggled into the country. In 1974 and 1975 it is estimated that smuggled cloth amounted to 765 million meters and 443 million meters respectively. This amounted to roughly 75% - 80% of domestic output and has led to severe competitive pressures on the domestic producers. In 1976 the incidence of smuggling apparently decreased rather sharply, and the industry is beginning to rebound. But there have been many complaints and requests for total bans on imports and tighter control of smuggling. 1/ The figure of 1.5 workers per loom is used by the Ministry of Industry. - 90 - 9.08 Imposing total import bans does not appear to be an appropriate solution to the problems. It would remove competitive pressure on the industry to rationalize and improve its competitive position. Moreover, as is shown later, a strong growth in market demand is expected over the next five to ten years and in those circumstances adjustments may be easier. Knitting 9.09 The knitting industry was started in 1952. Up to 1967, the prod- ucts were limited to coarse products such as T shirts, socks, underwear. Output amounted to 90.8 million meters in 1972 and rose to 208.0 million meters in 1975/76. The annual rate of growth was 25.8%. This growth was also accompanied by the introduction of new product lines such as tricot, double knit, laces, etc., and most of the new mills were using synthetic yarn such as nylon, polyester and acrylic bulky yarn as raw materials. 9.10 Almost all of the mills are concentrated in Java, particularly in DKI and West Java, as can be seem from the following table. In terms of numbers, 95.3% of the mills were in Java and 73.6% were in DKI and West Java. In terms of machines, DKI and West Java have 100% embroidery, 83.3% raschel, 82.8% flat and 69.2% circular knitting. Table 9.4 Knitting Industry in 1975/76 No. Region Enterprises Output No. Machines (m. meters) Circular Flat Raschel Embroidery 1. Java 224 207.0 5,418 939 570 52 DKI 73 65.3 2,000 399 78 30 West 100 78.9 1,877 455 412 22 Central 16 27.1 752 7 41 - DIY 3 6.6 51 - 27 - East 32 29.0 738 78 12 - 2. Others 11 1.0 182 92 18 _ Total 235 208.0 5,600 1,031 588 52 Source: Ditjentek, February 1976 Census. 9.11 The machines in the knitting industry can be divided into two groups. The first includes those established prior to 1967. These were mainly circular knitting machines of old and low technology producing coarse products. In 1972 there were 3,741 machines in this group. The second group includes those established after 1967. These consisted of raschel, warp, circular, and flat knitting. Their products are of much better quality. - 91 - 9.12 During 1969-75, the total number of knitting machines proposed to be installed and approved by the Government amounted to about 11,000, includ-- ing both foreign and domestic investments. Out of all foreign investment projects in that period, 58.3% in terms of mills and 44.9% in terms of investment have been producing. For domestic investment the corresponding figures were 61.5% and 74.4%. 1/ The number of new knitting machines already producing would be 6,625 (based on mills percentage) or 6,678 (based on investment volume). Combined with the old machines in place prior to 1969, the total machines in 1975/76 should have been much larger than 7,271, the figure shown in Table 9.4. These figures suggest that the replacement of old machines was taking place. This happened by the displacement of old mills, and apparently many entrepreneurs moved to other businesses. 9.13 Despite the ccmpetition from a large volume of imports in 1974/75, the impression from the interviews and the factory visits was that the mills are maklng a profit. The profit and cost calculations for some mills are given in Appendix I. Some of the products have even been exported. At present the knitting industry enjoys nominal tariffs ranging from 50 to 90% with 10 to 60% nominal tariff for raw materials. The real value is likely to be lower due to the presence of smuggling. Spinning, 9.14 This industry has grown rapidly from 1969 to 1976 as figures in the folLowing Table 9.5 show. From 482,000 spindles in 1969 it increased to 802,000 in 1973 and therL to 1,238,500 in February 1976. Repelita II sets the target at only 1,222,000C spindles by 1978/79. With this growth, the output of the spinning industry can now supply around 83% of the total yarn and filament input for weaving and knitting as opposed to around 55% in 1973. 2/ 1/ Dept. Parindustrian, Team Investarisasi Perizianan Proyek 2, PMDN dan PMA Buku I, Laporan Umum, Jakarta, March 1, 1976. 2/ The 83% was calculated from the Census data. The 55% was directly taken from Repelita II. - 92 - Table 9.5 Spinning Industry Ownership Number of spindles (000) 1969 1975 1976 P.N. Sandang Group Government ) 242 302 Pinda Sandang Group Regional Gov.) 135 GKBI Private ) 482 44 53 Private Private ) 441 789 /1 Other Government ) 8 8 Total 482 870 /2 1,152 /L3 Total output (000 ton) 33 80 /4 116 /5 Capacity (000 tons) 48 97.2 /4 137 /6 Source: Ditjentek and R.G. David notes on Textile Subsectors. /1 Including the Pinda group. /2 With the addition of 5 spinning mills at the end of 1975, the number of spindles became 982. /3 This data was for January 1976. The census in February 1976 shows that the figure was 1,238,500 spindles. /4 Commercial Advisory Foundation in Indonesia (CAFI) No. 621, Oct. 13, 1976. /5 February 1976. /6 Estimated. The data from Ditjentek is only .06 Ton/sp. (see Ditjentek: "The Development of Textile Industries in Indonesia", May 1976. - 93 - 9.15 In 1971, there were 18 mills with 484,000 installed spindles. In 1976, there were 56 mills with over 1.2 million installed spindles. The average size dropped from 27,000 to 22,000 spindles per mill. This means that the investment in spinning taking place during 1971 to 1976 has been in many smaller size mills. Taking 30,000 spindles/mill as a rough optimum size, this seeras to imply that the spinning industry may have lost some competitive edge. 9.16 In 1971, 89% of the mills and 88% of the spindles were concentrated in Java. In 1976 the concentration increased to 93% in terms of mills as well as spindles. In 1976, 96% of the total output of the spinning industry was produced by mills located in Java and 65% were in West Java. 9.17 The factory visits show that in general the mills were working three shifts per day, seven days per week. But spinning is less labor-in- tensive than weaving and knitting, and its competitivenes.o is less. The size of the new mills is smaller than 30,000 spindles on the average which would perhaps explain part of the problem. The factory visits tend to support this view. From the four mills whose cost data are presented in Appendix II, only two of them (B and D) could cover their full costs while the other two (A and C) cou]d not. Spinning also has a lower nominal tariff protection than does weaving and knitting, and although the coarse cotton yarns are banned from import, supplies from smuggling are available in the market. 9.18 Many if not most spinning mills are high cost producers. This is due partly to the high price of cotton. But it also results from the rather high waste in converting cotton into yarn. All in all, the competitive posi- tion of: the spinning industry is weaker than for weaving and knitting. Fiber Making 9.19 In 1976 there were four mills producing synthetic fiber. Their capacil:y as a whole for several kinds of products are given in the following table. Table 9.6 Fiber Making Industry in 1976 Product Capacity (Ton/year) Polyester staple fiber 41,790 Polyester filament yarn 10,950 Nylon filament yarn 6,330 59,070 Source: Ditjentek. All of the mills are located in West Java. - 94 - 9.20 This industry is facing competition from imported products. Ac- cording to a team recently sent by Indonesia to several countries in Asia, import was based on a dumping price which was much lower than the price and the production cost in the exporting countries. The data obtained by the team is given in the following table. Table 9.7 Inter-Country Comparison on Polyester Staple Fiber Taiwan Thailand South Korea Indonesia Production Cost (US$/Kg.) 1.60 1.80 1.75 1.90 Selling Price (US$/Kg.) In the Country 1.24 1.70 1.55 1.32 Export (f.o.b.) .88 .95 .93 Source: Laporan Team Evaluasi Kalkulasi Polyester staple fiber, November 1976. These figures suggested that the main source of the prob- lem was not the difference in production cost but in the pricing policy. 9.21 The fiber plants are in a somewhat poor position now, and the exist- ing plants seem to have enough capacity to satisfy current demand. Competition from imports has made plans for domestic expansion appear unfavorable. But it is expected that in the future the demand for blended fabrics (involving synthetics) is likely to rise more rapidly than for cotton fabrics, and the long-term prospects for capacity expansion appear much more favorable, pro- viding that domestic producers can compete with imports at prices comparable to those applying to the home markets of exporters (i.e., not at a dumping price). At present domestic producers suffer cost disadvantages vis-a-vis imports primarily because of raw material freight costs, higher interest charges in Indonesia, higher electric power charges (per Kg. of product), and even higher labor charges per unit output (because of low productivity). Finishing. Dyeing and Printing 9.22 The finishing, dyeing and printing industries are concentrated in West Java. Many enterprises are quite small and concentrate on traditional products such as batik. In 1970, the capacity of the existing printing units was around 352 million meters. This capacity was higher than the output in 1975/76. The capacity of the existing dyeing and finishing units in 1970 was around 313 million meters. - 95 - 9.23 The finishing, dyeing and printing mills can be divided into two broad categories: those not integrated and those integrated with weaving and knitting mills. The latter have processed their own knitted and woven prod- ucts and sold services to others that did not have the facilities. On the other hcnd, the non-integrated mills have had to rely on buying materials from the market or have undertaken job orders. They are facing difficulties both in getting consistent quality of material from the internal market and in getting continuous job orders. Almost all the new mills are integrated units with balanced capacities. Excess capacity has prevailed in this industry, and the new demand in the next ten years is expected to be satis- fied by the integrated type of investment. The non-integrated mills will continue to have difficulty in maintaining production. Garment Making 9.24 Compared to other segments in the textile industry, garment making is still a very small segment. In 1975/76 there were 123 enterprises and 4,267 sewing machines in. this segment of the industry as given in the follow- ing table. Table 9.8 Garment Making Industry Number Number of of Firms Sewing Machines 1. Java 119 3,843 DKI 71 2,076 West 22 872 Central 9 501 DIY 2 35 East 15 359 2. Others 4 424 Total 123 4,267 Source: Textile Industry Census, February 1976. In 1974, it was estimated that around 85% of the domestic clothing consump- tion was bought in the form of cloth which was then given to local tailors to be sewn. Only 3% of this consumption was supplied by the real garment industry, while 7% was supplied by the home industry and the rest 5% was underwecr. - 96 - 9.25 It is very clear that the garment industry in Indonesia is in its infancy. It has not developed at all. The present capacity is miniscule by any standards. As is shown later, the major change in the whole of the textile industries should be a very rapid growth in garment making. It is, without doubt, the major industrial sector that could absorb labor in the future. Batik 9.26 The batik industry is one of the traditional industries of Indonesia and will continue to grow at a slow but steady rate. Most of the batik under- takings are under one association called GKBI (Indonesian Batik Cooperative Association). The GKBI supplies the raw material and the finishing services to the undertakings and in some cases also helps in marketing. The labor employed 1975/76 is estimated at about 43,000 in block printing and 250,000 in traditional batik. Most of these products are domestically consumed. In 1974 the total batik output was estimated at 29.4 million pieces or around 73.5 million meters. Future Trends 9.27 The consumption per capita of textiles in 1969/70 was 6.2 meters, and in 1974 rose to about 10 meters. The growth rate of consumption per capita during Repelita I 1969/70 - 1973/74 was around 11.3% per year. The projected figure for Repelita II 1974/75 - 1978/79 is 10 meters in 1974 to 11.5 meters in 1978/79 or a growth rate around 3.9% per year. For the period 1979/80 - 1983/84, the consumption per capita is projected to be 18.0 meters in 1983/84 or a growth rate around 9.4% per year. These growth rate projec- tions are suspect. The 11.3% growth rate in Repelita I followed by a drop to 3.9% in Repelita II and then an increase to 9.4% as projection for Repelita III seems inconsistent. It appears that the projection figure in Repelita II is too low. 9.28 In order to make a projection of textile consumption per capita for the future, a comparison was made to the experience of other (tropical) coun- tries. Data were collected on 62 countries and consumption per capita was related to income (as measured by the GDP). Several functional forms for the relationship were tested and finally an equation that is linear in logarithms was chosen. This gave the best fit and has the advantage that the coefficient of the independent variable shows the elasticity of consumption of textiles per capita to income. In this way a projection of future consumption based on the average or normal experience of other countries was derived. The re- sults of this statistical analysis are as follows: - 97 - ln y = -2.8332 + .6775 ln x (.3113) (.0510) 2 R = .65 F = 112.0 where y equals consumption of textiles per capita x equals GDP per capita in 1970 US$. 9.29 The results indicate an income elasticity of demand of only .68, which :is lower than other estimates that have been made for Indonesia, which typically have been greater than one. But even with what may be a conserva- tive estimate of the income elasticity of demand at Indonesia's level of per capita income, the projected rate of growth of consumption of textiles is substantial. Per capita inc.ome in 1986 is estimated at $250 based on recent growth trends. Then the estimated value of consumption per capita in 1986 is 2.5 Kg. If Indonesian consumption per capita 1986 is assumed to be on the regression line, and taking the consumption per capita in 1973 as 1.3 Kg., then the consumption per capita growth rate is 5.2% per year. With the population growth rate 2.1% per year, the total consumption growth rate is 7.3% per year. 9.30 The total knitting and weaving output was 63% of domestic output plus import in 1969 ancd then increased to 70% in 1975/76. In 1986, this figure is expected to be higher and is taken to be around 80% for the sub- sequent discussion in this paper. In 1975, the census showed that knitted output was 19.2% of total Indonesian knitting and weaving production. It is assumed that the percentage of knitting output is still increaLsing and that in 1986 will settle at about 25%. Then with a figure on exports, the output of Indonesian production could be broken down into knitting anLd weaving products. 9.31 The export figures for textile products so far are very small. They were less than 1% of the corresponding consumption figures. Based on their assessment of the Indonesian textile industry, H.J. Blydenstein and M. Minlce said: "Provided a sizeable percentage of the present applications for new investments are approved and effectuated at a reasonable machine utilization, an estimate of an export volume of 250-400 m. meters in 1979 does not seem unrealistic. This metrage undoubtedly can be more competi- tively exported in the form of garments rather than piece goods". 1/ If the consumption in 1979 is estimated from the regression above, this level of export is 13.6% - 2].7% of total consumption in that year. 1/ H.J. Blydenstein and M. Minke, Observations on Garment Making in Indonesia, Jakarta, September 1974, p. 10. - 98 - 9.32 The fiber composition of output has been changing. In 1970 cotton accounted for 79% of output, synthetics (nylon, polyester, acrylics) for about 17%, and rayon for about 4%. By 1979 it is estimated that cotton will account for just under 60%; synthetics will increase to about 35% and rayon to 5%. 9.33 Several other targets are also acceptable for the analysis. The production target for yarn is taken at 80% of the yarn consumption. In the conversion of yarn into woven and knitted fabrics it is assumed that the waste is 10%. The same assumption is also applied for fiber. The production target for synthetic fiber is 80% of consumption. Analysis of Representative Projects 9.34 Based on the foregoing estimates of future total consumption, ex- ports, the level of self-sufficiency in domestic production, and the other points raised above, in the remainder of this chapter an analysis is made of "representative" projects in each of the main divisions of the industry: spinning, weaving, garment making, and fiber making. The objective is to analyze potentially efficient projects in each of the divisions, but not to attempt to identify these with a specific project with all the details that that requires. For example, in the spinning industry the representative project is one that has 30,000 spindles and has investment costs derived from estimates made for such a plant in 1972, as updated to 1976. Product prices are those existing typically in 1976. 9.35 The purpose of this type of analysis is not primarily to identify a specific investment project, but to compare the relative profitability and/or comparative advantages that Indonesia has in the different divisions of the textile industry. It is an attempt to provide a rough screening whether investments in spinning, weaving, garment making, or fiber production are apt to be best. This is a rough screening since calculations of economic (as opposed to market) prices and costs often had to be treated in a crude fashion or ignored entirely. Consequently, the results of the analysis are useful primarily as indicators of directions for further detailed analyses. The results are very definitely not intended to recommend operational deci- sions on investment programs. 9.36 In the project analyses that follow, many assumptions are made for simplification: - The scrap value at the end of the lifetime of the proj- ect is taken to be zero. - The project lifetime is assumed ten years. - Depreciation is taken straight line. - Working capital equals three months output and this is released at the end of the lifetime of the project. - 99 - No loan is assumed (all equity investment). - No reinvestment is assumed. - Investment is evenly spread over three years. - Production starts in Year Three, directly at full capacity. - Wage and salary on the average is taken at Rp. 216,000 per man year. 9.36 The characteristics of representative investment projects have been derived from previous analyses of the textile industry and from work of the mission itself. Brief descriptions of these projects plus other pertinent market and price information are presented below. 9.37 Weaving: The representative investment project has been derived from prior work done by Werner International as updated by the mission. No. of Power Looms: 400 Capacity: 3.7 m. lbs. or 15.6 m. meters of 26's/26's. Warp and Weft: 60 x 60 ends and picks per sq. inch. No. of Employees: Supervisory 20 - Production 400. Investment Cost per P'lant: $5.3 million. This is not the most automated capital intensive type of plant. Based on the prior demand projections it is estimated that by 1986 543 million meters of new capacity will be justified, after allowing for the fact that the number of hand looms is assumed to stay constant and that domestic production will account for 85% of total supply (i.e., 20% of imports minus 5% exports). The largest demand will be in cotton products. The representative p].ant is assumed to produce 36 inch T/C shirting (annual capacity 12.8 million meters). 1/ The product price is assumed at Rp. 350 per meter (see Appendix II). 9.38 Spinning: The representative investment project is based on a plant with 30,000 spindles and the plant is assumed to produce cotton yarns with counts in the 20's, 30's, and 40's. It is recognized that by 1986 the composition of output will, change toward synthetics but cotton will still be the major part of output. The 1986 demand will require 172,000 tons of new capacity on the assumption that domestic output will supply 80% of total re- quirements. The representative project has the following characteristics: No. of Spindles: 30,000 Capacity: 3,677 tons per year 1/ 44 inch may be becoming more common. - 100 - Employees: Supervisory - 30 Production - 600 Investment Cost of Plant: $14.4 million. Appendix II shows the cost calculation for cotton yarn, from which rates of return and other measures have been calculated. 9.39 Fiber Making: Calculations indicate that domestic production of polyester yarn is not an attractive investment in the time period up to 1986 since demand is not expected to increase sufficiently to support one plant of minimum efficient size. However, the demand for nylon filament yarn is somewhat more attractive. Current domestic production capacity is around 6,300 tons per year and by 1986 one plant of minimum efficient size (20,000 tons per year) may be justified. The characteristics of the project are as follows: Product: Nylon Filament Yarn Capacity: 20,000 tons per year Employment: 575 Investment Cost of Plant: $119 million. 9.40 Garment Making (Shirts): As has been indicated earlier, it appears that the garment making industry may offer the most favorable market condi- tions for expansion. The existing mills have already been able to export, and face a growing domestic market. Many types of garments could be pro- duced; the representative project is a plant for manufacture of shirts, with the following characteristics: Product: Shirts Capacity: 180,000 dozen or 2.16 million pieces per year Employment: 500 Investment Cost of Plant: $3.85 million. Preliminary calculations seem to indicate that Indonesia may have a strong competitive edge even over Japan or Taiwan in this labor intensive industry, since productivity in Indonesia (shirts in man-day) is about one-third to one-quarter the productivity in the other countries but hourly wage rates are one-twentieth as much. 9.41 Summary cost calculations for each of the four representative projects in weaving, spinning, fiber making, and garment making are given in Appendix II. These calculations are then used to compute the internal rates of return and various other measures indicating the "worth" of the projects. The results are shown in Table 9.9. - 101 - Table 9.9 Summary of the Project Analyses /1 Projects Weaving Spinning Fiber Making Garment Products Shirting /2 Cot. yarn /3 Nylon FY Shirt A. IRR & SENSITIVITY ANALYSIS 1. Internal Rate of Return 11.8% -5.0% -4.7,y 17.0% 2. Factor by which ouitput price would have to be multiplied to yield 10% IRR, holding inpujt prices constant. .97x 1.20x 1.52x .87x 3. Factor by which ouitput and input prices would have to be multipLied to yield 10% IRR. .9Ox 1.69x 2.10x .71x B. FINANCIAL RETURN Accounting Rate of Return /4 16.7% -5.6% -6.6,' 25.6% C. FX EFFECTS 1. FX investment cost (Rp.m.) 2,169 3,861 37,842 1,334.8 2. FX cost as % of total investment 65.5% 52.6% 65.9%' 55.0% 3. Annual FX saved/earned as % of 1 47.8% 38.7% 12.66% 160.4% D . EMPLOYMENT EFFECTS Capital cost per direct job created (Rp.m.) 7.9 11.7 100.0 3.2 /1 - The project wilL last 10 years, at the end of which the scrap value is assumed 0, and the working capital, i.e., 3 months stock of out- put materials i1S released. - Investment is evenly spread within 3 years. No loan and reinvest- ment assumed. ])epreciation is taken straight line. - Started producing in year 3, directly at full capacity. - Wage and salary on the average is taken Rp. 216,000 per man year. /2 Made of T/C, 45's. /3 Cotton 20's, 30's and 40's. /4 Defined as Net Proi-it After Taxes over average investment, i.e., working capital plus one-half of fixed capital. - 102 - 9.42 The comparative calculations indicate quite closely that garment making offers the best opportunities for investment within the textile industry, followed by weaving. Both spinning and fiber making appear quite unattractive. The internal rate of return is highest in garment making and the investment cost per job created is the lowest. The sensitivity measures and the foreign exchange effects are also generally the best. On these same points, weaving appears to be a favorable field by comparison to the other two. 9.43 It is important to emphasize the limitations of the analyses that were conducted. Due to limitations of time and availability of data the analyses are crude; the absolute values, such as the internal rate of return, are not necessarily significant by themselves, but they are valid for making comparisons among projects, and that is the primary purpose. This is a rough means of attempting to screen the various alternatives and to indicate the directions for detailed analyses. For that purpose the analyses are valid and useful. 9.44 We have not attempted to shadow price the inputs nor to identify the representative projects with a specific plant location. The product lines seem relatively homogeneous and do not reflect the fact that in actual situations the product-mix might be more complex (e.g., a garment plant might produce other products in addition to shirts). Finally, the costing and price selections are based on current conditions as best we could determine them, but a closer analysis might reveal differences. 9.45 Subject to all the above qualifications, the analytical results do reveal in what directions relative priorities lie in the textile industry. Even with a more detailed analysis it is very unlikely that the relative order of the results would be changed though the margins of difference might well be less. 9.46 It is suggested that in evaluating proposals for further devel- opments in the textile industry, a greater attention be given to the oppor- tunities in garment making and weaving. - 103 - KPPENDIX I Profit and Cost Calculation of Some Knitting Mills A B cost per dozen cost per dozen Variable cost Rp. % Rp. % Raw material 1,227 47% 1,702 61% Auxiliary materials 727 28 214 8 Direct labor 114 4 180 6 Maintenance 18 1 65 2 Selling cost 68 3 34 1 Others 57 2 - Total variable cost 2,211 85 2,194 78 Fixed cost Depreciation 261 10 44 2 Indirect labor 64 3 108 4 Insurance 3 - 21 1 Maintenance - - - Interest 60 2 151 5 Others 1 - 277 10 Total fixed cost 389 15 606 22 Total cost per dozen 2,600 100 2,800 100 Product underwear underwear Total output per year 45,000 dozen 275,000 dozen Sales revenue per dozen 2,977 3,676 Gross profit per dozen 377 876 Corporate tax 165 385 Net profit per dozen 212 491 - 104 - APPENDIX I Cost Structure of Some Spinning Mills (Rp/I) A L B C D Raw material 120600 58% 71%/ 93200 70% 170200 81% 124000 87% Aux. material 2300 1 1 9 Wages 10200 5 W 10 8200 6 12300 6 11700 8 Salaries 5600 3 3 Depreciation 6500 3 4 9600 7 4900 2 1500 1 Maintenance & spare parts 8500 4 5 7800 6 3900 2 4300 3 Utilities 7600 4 4 7 3900 2 4 Interest 40500 19 - - - 12200 6 - - Others 7800 4 5 14500 11 3400 2 1300 1 Total cost 209600 100% 100% 133300 100% 210800 100% 142800 100% Product avg. count 25.5's 29's 30's 23's Output 10000 g 13000 g 16000 % 19000 g Sales Revenue/3 172100 182000 195000 167000 L A is for 1975. Others for 1976. /2 Without interest payment. /3 Recalling that cotton yarn of 12's and 12'2 up to 42's and 42's have been banned from import, the CIF price would likely be significantly lower than the market price. The Ditjentek data on CIF are Rp. 173000, Rp. 20300 and Rp. 220000 per $ for 20's, 30's and 40's respectively. It is worth noting that the CIF price does not necessarily reflect the cost of standard international spinning mill. - 105 - APPENDIX II Cost Calculations of 36" Blended Shirting (capacity 12.8 m. meter p.a.) Rp/meter Material 168 Wages and salaries 7 Maintenance & spare parts 4 Depreciation 17 Others 16 212 Sales tax 5% 11 223 Sales revenue 275 /1 Gross Profit 52 Taxes 23 Net profit 29 /1 The retail price Rp. 350. Cost Calculation of Cotton Yarn (a mixture of 20's, 30's and 40's, one third each) (capacity 3,187 ton or 17,550 bales p.a.) (Rp/%) Raw Material /1 127,820 Wages and salaries 7,760 Maintenance & spare parts 6,780 Depreciation 33,930 Others 14,500 190,790 Sales tax 6% 5,724 196,514 Sales revenue /2 182,667 Loss 13,847 /1 The price of cotton is taken 70w/lb. /2 The price of 20's, 30's and 40's are taken at Rp. 150,000, Rp. 195,000 and Rp. 198,000 per bale. - 106 - APPENDIX II Cost Calculation of Nylon Filament Yarn (capacity 20,000 ton p.a.) (Rp/kg) Raw material 501 Auxiliary material 77 Wages and salaries 49 Maintenance & spare parts 36 Depreciation 249 Technical fee & royalty 36 Insurance 14 Selling cost 35 Others 59 1,056 Sales tax 5% 53 1,109 Sales revenue 1.000 Loss 109 Cost Calculation of Shirt Making (capacity 2,160,000 pieces p.a.) (Rp/piece) Raw material 675 Wages and salaries 50 Maintenance & spare parts 36 Depreciation 74 Technical fee & royalty 5 Insurance 3 Others 20 863 Sales tax 5% 43 906 Sales revenue 1.250 Gross Profit 344 Taxes 151 Net Profit 193