CONFIDENTIAL ~PORT NO: 11758-I~ID INDONESIA PRODUCTION FORESTRY: ACHIEVING SUSTAINABILITY AND COMPETITIVENESS FILE COPY CONFIDENTIAL Report No: 11758 IND Type: SEC October, 1993 This is a draft worki.~g paper, intended to promote discussion on the forestry sector in Indonesia. It should not be regarded as the final and official position of the World Bank on the subject matter discussed. - i - CURRENCY EQUIVALENTS Before November 15. 1978 US$1.00 - Rp 415 Annual Average 1985-91 1985 US$1.00 - Rp 1,111 1986 US$1.00 - Rp 1,283 1 1987 US$1.00 - Rp 1,644 1988 US$1.00 - Rp 1,686 1989 US$1.00- Rp 1,770 1990 US$1.00 - Rp 1,843 1991 US$1.00 - Rp 1,950 1992 US$1.00 - Rp 2,030 FISCAL YEAR Government April 1 to March 31 Bank Indonesia April 1 to March 31 State Banks January 1 to December 31 1 On September 12, 1986 the Rupiah was devalued from US$1.00 - Rp 1,134 to US$1.00- Rp 1,644. [There was also an earlier devaluation on March 30, 1983.] - ii - ABBREVIATIONS. ACRONYMS AND INDONESIAN TERMS ADT -Air Dry Tonne AIFTA - Association of Formalin & Thermosetting Adhesives Industries AKRSP - Aga Khan Rural Support Programme AMDAL - Environmental Impact Assessment APHI - Logging Concession Owners Association APKINDO - Plywood Manufacturers Association ASMINDO - Indonesian Furniture and Handicraft Producers Association BAKN - Agency for Civil Servants Administration BAPEDAL - Environmental Impact Management Agency BAPPEDAs - Provincial Planning Boards BFL - Basic Forestry Law BIPHUT - Inventory and Forest Mapping Centre BISHH - Forest Products Information and Certification Center BKPH - Forest Sub-District BKSDA -Natural Resources Conservation Centre BLK - Forestry Training Centre BPA - Natural Silk Centre BPK - Forestry Research Centre BPKM - GOI Investment Coordination Board BPPB - Seed and Inspection Centre BRLKT - Rehabilitation and Soil Conservation Centre BTP PERBENIHAN - Seed Technology Centre BTP DAS -Watershed Management Technology Centre BTR - Reforestation Technology Centre CINTRAFOR - Centre for International Trade in Fares Products cum - Cubic Metre DBMT - Directorate of Development for the Most Isolated (Ministry of Social Affairs) DENR - Deparnnent of Environment and Natural Resources DG - DirectOrate General DINAS - Provincial Government Office DR - Reforestation Levy (component of total Government of Indonesia standing timber fee transferred to Ministry of Forestry for reforestration purposes) FAO - Food and Agriculture Organization FICP I - First World Bank Forestry Institutions and Conservation Project FICP II - Second World Bank Forestry Institutions and Conservation Project FICP III - Third World Bank Forestry Institutions and Conservation Project FICP - Fore-~!ry Instirutions and Conservation GEF - Global Environment Facility GTZ - German Agency for Technical Cooperation HIKKINDO - Forestry Consultants Association of Indonesia - iii - HPH -Natural Forest Logging HPHTI - Concession Rights for Industrial Timber Estates HRAF - Human Relations Area Files HTI - Industrial Timber Estates IFAP - Indonesia Tropical Forestry Action Programme IFTA - Indonesian Flora & Fauna Trade Association nrn - Forest Products Royalty (component of total Government of Indonesia standing timber fee which is transferred to Ministry of Finance) INFORMAN - Indonesia Forest Management Model INHUTANI - State-Owned Forest Concession Company INKINDO - Indonesian Consultants' Association INTAG -Inventory and Land Use Planning ISA - Indonesian Sawmillers Association I'ITO - International Tropical Timber Organization JAC - Japan Architectural Center Kanwil Kehutanan - Ministry of Forestry Regional Offices KLH -State Ministry for Population and Environment (split into two Ministries in 1993 reallocation of Ministerial responsibilities) KPHP - New Forest Zoning System LGUs -Local Government Units LITBANG - Agency for Forest Research and Development m3 - Cubic Metre MoFr - Ministry of Forestry MOl - Ministry of Industry MPI - Indonesian Forestry Community NGO - Non-Government Organization NIPINDO - Indonesian Plywood Manufacturers Association (APKINDO) Trading Organization in Japan NPV -Net Present Value NTFP - Non-timber Forest Products PH - Directorate General of Forest Utilization RePProT - Mapping Based on Regional Physical Planning Program Ministry of Transmigration RRL - Directorate General of Reforestation and Land Rehabilitation RPH - Forest Resort SBKSDA -Natural Resources Conservation Sub-Centre SBIPHUT - Inventory and Forest Mapping Sub-Centre (SBIPHUT) SBRLKT - Rehabilitation and Soil Conservation Sub-Centre SITC - Standard International Trade Classification SKMA - Senior Forestry High School TAG - Transmigration Advisory Group TFAP - Tropical Forestry Action Programme TGHK - Ministry of Forestry Official Concession Map Boundaries TKIHH - Coordination Team for Forest Industries TN -National Parks TPTI - Indonesian Selective Cutting and Planting Forest Management System WALID - Environmental Forum for Indoneisa - iv - PRODUCTION FORESTRy: ;-A~~YJNG SUSTAINABILITY AND COMPETITIVENESS Table of Contents Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (vi) CHAPTER I: INDOl\TESIA'S ECONOMY AND THE ROLE OF THE FORESTRY SECTOR The Indonesian Economy: History and Prospects . . . . . . . . . . . . . . . . . 1 The Role of the Forestry Sector 2 A Comprehensive Approach to Indonesia Forest Sector Strategy . . . . . . . . 8 Focus, Organization and Objectives of this Review . . . . . . . . . . . . . . . . 13 CHAPTER ll: FOREST RESOURCES Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Forest Area and Resource Availability Projections . . . . . . . . . . . . . . . . 15 Factors Influencing Resource Estimates . . . . . . . . . . . . . . . . . . . . . . . 16 CHAPTER ill: FOREST MANAGEl\1ENT Introduction: Analysing Options for Natural Forest Management . . . . . . . . 25 Economic Analysis of Sustainable Management Alterntives . . . . . . . . . . . 26 Results of INFORMAN Analyses . . . . . . . . . . ·. . . . . . . . . . . . . . . . . 28 Multiple Use Forest Management . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 The Concession System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Potential Improvement of Natural Forest Wood Availability . . . . . . . . . . . 34 Improving Management of Forest Operations . . . . . . . . . . . . . . . . . . . . 35 The Plantation Sector and the HTI Scheme . . . . . . . . . . . . . . . . . . . . . 42 The Economics of the HTI Scheme . . . . . . . . . . . . . . . . . . . . . . . . . . 43 HTI Scheme Implementation and Observations . . . . . . . . . . . . . . . . . . . 46 Some Conclusions on the HTI Scheme . . . . . . . . . . . . . . . . . . . . . . . . 48 Forest Communities: Rights and Sustainability . . . . . . . . . . . . . . . . . . . 49 -v- CHAYfER IV: THE WOOD PROCESSING INDUSTRIES: POTENTIAL AND ISSUES Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 Market Developments for Tropical Forest Products . . . . . . . . . . . . . . . . 53 The Indonesian Forest Industries Sector: Recent Issues . . . . . . . . . . . . . . 57 The Plywood Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 The Sawnwood Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 Woodworking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Pulp and Paper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76 CHAPTER V: PRICING INDONESIA'S FOREST RESOURCES Introduction: The Role of Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 Fees for Standing Timber: Economic Rent . . . . . . . . . . . . . . . . . . . . . 82 CHAPTER VI: POLICY AND INSTITUTIONAL ISSUES: AN AGENDA FOR REFORM The Motivation for Change in Forestry . . . . . . . . . . . . . . . . . . . . . . . 89 The Policy Agenda . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 The Institutional Implications of Change . . . . . . . . . . . . . . . . . . . . . . . 96 Improving Sustainable Forest Management: An Inspection Service . . . . . . . 105 Improving Sustainable Forest Management: Using Increased Revenues to Build Efficiency and Equity . . . . . ·. . . . . . . . . . . . . . . . 107 ANNEXES 1. Assumptions Used in the INFORMAN Analysis . . . . . . . . . . . . . . . 111 2. Problems in Attaining Sustained Yield Forest Management under a 35 year Polycyclic Harvesting Regime . . . . . . . . . . . . . . . 119 3. Comparison of Timber and Non-Timber Values of Tropical Forest . . . . 123 4. The Legal Status of Forest Communities' Rights to Resources and Territories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 5. Wood Processing Sector: A Spreadsheet Model for Assessing Changes in Valued Added and Employment Arising from Shifting Allocation and Increasing Recovery Rates . . . . . . . . . 135 6. Indonesia Forestry Sector Institutions and Personnel . . . . . . . . . . . . . 139 7. Sustainability and Forest Management . . . . . . . . . . . . . . . . . . . . . . 153 (vi) INDONESIA PRODUCTION FORESTRY: ACIDEVING SUSTAINABILITY AND COMPETITIVENESS Executive Summary INTRODUCTION i. The role of forests. Indonesia bas one of the largest tracts of tropical moist forest remaining in the world: estimates vary, but something in the order of 100 million hectares of the country is forested. Indonesia is highly dependent on this resource. In measurable economic terms, total output from the sector is around $8 billion per annum, which amounts to about 7% of GOP, and 20% of non-oil exports. It is, however, of greater significance to the economic development of Indonesia than is indicated by these figures. Many millions of people in Indonesia earn a significant part of their income directly from the forest, through the extraction of nontimber forest products. Millions more depend heavily on the soil and water quality benefits provided by forests in the major watersheds: these are vital to agriculture, which remains a major livelihood in Indonesia. ii. From the viewpoint of the global community, the Indonesian rainforest resource represents one of the most species rich ecosystems left on earth; it is also a massive carbon sink - a matter of some significance given current concern about emission of greenhouse gases into the atmosphere. m. The resource: an asset, and a source of contention. Possession of a large forest resource represents a major asset to Indonesia, but in the context of Indonesia's rapid economic growth imperative, it also sets up conflicts: iv. There are strong differences in opinion in Indonesia as to bow forest land should be used. Some of the land occupied by forests is potentially convertible into productive, profitable, and sustainable alternative uses. Such conversion offers not only relatively high returns, but gainful occupation for rural dwellers who, in many instances, have few alternatives. Although some would disagree, it is both likely, and inherently logical, that such land should be converted. However, there will be a gradation from land of this type, to land which should remain under forest. The latter includes not only areas of biodiversity value, but also areas where sustainable forest management will be the most effective use of the land, for reasons of terrain, soil type, location, infrastructure factors, and so on. Given the very large area of forest, it is reasonable to argue that most of it will not be converted to intensive crop use, for reasons of investment capital and market demand limits. The choice, more often, will be between retention as forest, or conversion to various forms of shifting agriculture, some of which will be neither sustainable, nor particularly profitable from the national point of view. v. . Where the line between permanent forest and conversion forest is drawn, and by whom, is a major source of contention in the sector. This review takes the view that, in the Indonesian context, decisions of this nature are essentially political. Better information, and streamlining of institutional structures and consultative decision making frameworks, will improve the quality of decisions made, but will not transform them into apolitical ones. This is an important point, because it defines the need for inputs into the sector, to a large extent. While every effort to codify and objectify all major land use decisions by use of information and technology should be made, some vital changes in approach are needed now, and should be made without delay. (vii) vi. One such area of change, requiring an essentially political decision, relates to the role of local and regional governments. It will be argued (see under The Interest Groups below) that these institutions presently receive very little of the proceeds from forest production - and for areas under conservation or preservation, they receive even Jess. Revision of the revenue sharing formula is needed, to ensure that local and regional governments are given some incentive to participate in sustainable management or preservation: their role, especially in working with communities likely to encroach upon forests, will be crucial. vii. Even when lines are drawn, and institutional jurisdiction and revenue shares are clarified, internal conflict in managing the resource is by no means eliminated. A forestry agency or other land management agency may, in theory, take a long term view of the resource under its management, but this view may not be shared by private sector users of the resource, nor by local populations who perceive more value in the land than in the trees on it. Both such groups are likely to have stronger field presence and impact than the regulatory agencies. The classic response to this problem is to attempt to strengthen the field implementation capability of the regulatory agency . Results from this approach - in Indonesia and elsewhere - have been disappointing. Regulatory institutions may well require strengthening, but they require both policy and institutional reform more urgently. The need for policy development is a central argument of this review, and institutional reform must accompany it. DEFINING THE FRAMEWORK FOR POLICY ANALYSIS viii. The focus on production forestry. It is important to consider the focus of a report of this nature. There is already a considerable body of recent work, by GOI, the Bank and other donors and interest groups, focussing on conservation and biodiversity in the forest: there is also considerable current and planned investment in this area. However, the results of all this work will be placed at considerable risk if production forestry (and its aftermath) is not controlled in Indonesia. Presently, forest operations cover some 700 000 hectares per annum. This figure is fairly close to recent estimates of deforestation in the country, and it is clear that much deforestation occurs in logged over land. ix. It should not be assumed, however, that drastically reducing or eliminating logging (even if this were politically and economically possible) would reduce deforestation. In fact, quite the reverse could be expected, since the value of regenerating forest in such circumstances would be zero, whereas the value of the land under alternative uses would be considerable. x. The view taken in this report is that sustainable managed production is the only approach which will allow some of the major soil, water and carbon sequestering values of the forest ·to be preserved, and which at the same time will provide a buffer for conservation and protection areas. This approach requires that all interest groups recognize that sustainable yield forestry is both economically and environmentally acceptable on the permanent forest estate, and this report devotes considerable space to these matters. Although there is no substitute for dedicating large areas of natural forest to conservation and preservation uses, and protecting these, there is considerable potential for conservation and preservation work to be done at a smaller scale within forest production areas, provided adequate capacity to plan, supervise and monitor exist. xi. For these reasons, this report focusses heavily on production forestry in Indonesia. It argues that regaining control of production forestry is a necessary condition for conservation and preservation work, and that the two activities must be pursued simultaneously. xii. The questions Indonesia must now ask, in relation to the production forest resource, are: Can an effective forest cover - that is, one capable of maintaining a significant level of non- wood as well as wood output benefits - be sustained under existing policy and institutional circumstances in Indonesia? (viii) Are the acttvJtJes and arrangemehts prevalent in sector operations compatible with the Government's primary objectives on policy alleviation and equity - given the large numbers of poor people living in or near the forest areas? xm. Policy development under uncertainty. At the:: iligbest political level, Indonesia bas already made important decisions about forest land use. It bas committed itself to retention of some 84 million hectares of natural forest cover in the long term. It bas committed itself to implementation of the guidelines for sustainable forest management issued by the International Tropical Timber Organization, by year 2000. Importantly, in the Indonesian context, support for this position has been offered by significant groups within the private sector. This review accepts that the targets for forest area laid out by the Government are reasonable. However, as is common in many countries, particularly where environmental issues are concerned, the gap between official policy and implementation is large, and a business-as-usual approach will not suffice. xiv. This review raises and discusses a number of examples where policy and practice diverge. Management planning and field supervision of forest operations do not conform with requirements laid down in legislation and regulations. The physical location of concession areas, protection and conservation sites, and other classifications frequently overlap each other, and this problem is compounded by subsequent location of Transmigration and HTI (plantation) projects in common areas. There are now broad national goals requiring that natural resources be used for maximum economic gain (within prescribed environmental constraints), that distribution of such gains be more equitable, and especially that local communities living in close proximity to such resources should be given a more proactive role in the sustainable management of such resources. However, it is apparent that progress with these objectives has been slow in forestry. xv. In some cases in the past, a Jack of political will to deal comprehensively with policy and implementation problems has been apparent. Now, it can be said that where forests are concerned, there is strong awareness at the highest levels of government of the need to implement genuinely sustainable use and conservation. There remains the problem that political decisions made at the higher levels are not yet being transmitted downwards into effective implementation. In some cases this is due to the relative newness of the objectives: for example, the greater involvement of local communities in forest management, while always present in statutes, has only recently come to prominence as a national objective, largely on the strength of its close association with major poverty alleviation goals which have been assigned high priority by the Government of Indonesia. There are also differences in perception at different lev~Js of government in Indonesia caused, in many cases, by the financial arrangements that pertain. An example of this (discussed under The other levels of government below) is the relatively low level of funding received by provincial governments from forest operations, and the even lower outlays they receive for conservation forest activities. Some provinces (especially those upstream from the major consequences of deforestation) have more interest in conversion of forests into landuses from which they can generate more taxation and other revenues, than retention - regardless of the economic and environmental attractiveness of retention from the national viewpoint. Lastly, as will be argued and demonstrated in various places in this report, the lack of trained personnel and appropriate institutional designs and objectives inhibits implementation of new policies even where these are generally accepted at all levels of government. This study will emphasize the importance of solutions which rely on mobilizing all available human resources - the private sector, NGOs, academics and others - rather than the traditional approach of relying· primarily on expansion of the duties and capabilities of (already overtaxed) public institutions alone, to deal with the new demands. xvi. A technical problem with major policy implications which arises at the outset is that the resource and extraction data base, upon which decisions at the macro and micro levels are made, is unreliable. Even if current estimates of the overall area of forest in Indonesia are reasonable, there is considerably more doubt that the area estimated as being available for commercial exploitation (based on the criteria used to define this) is as large as implied by official estimates. Some data and analyses cited in Chapter II of this review suggest (ix) that the area which qualifies under the criteria as normal production forest might be one third smaller than is put foiWard in official figures. xvii. Estimates of log volumes extracted from the forest are equally unreliable, and there is some conflict even among official sources as to what current levels of log extraction are: numbers ranging from 21- 28 million cubic meters p.a. for recent years appear in annual figures, but other sources estimate average levels of extraction in excess of 30 million cum p.a. for recent years. Based on estimates of log input required for recorded forest product output, this review concludes that at least 36 million cum p.a. would need to be extracted to satisfy recorded output and, since it is known that significant processed output is !!Q! recorded, that probably more than 40 million cum p.a. are currently being taken from the forest. xvili. Whether this output is beyond the capability of the forest to sustain on a long term basis is difficult to comment upon at the aggregate level: in the absence of reliable inventory and growth and yield data (some of which will be forthcoming from work in band in the Ministry of Forestry and elsewhere), the aggregate capability of the productive forest estate to regenerate log volume is unknown. Moreover, as is elaborated upon at various places in this review, the unit recovery of log volume from a given area, and the unit output of processed output from that volume, are not fixed, but vary (largely, it is argued, on the basis of log pricing and other policy instruments which impact upon forest operations). The underlying message put forward in the review, in this respect, is that of all the inputs needed in forest processing, logs are most likely to become in short supply: in the short to medium term, measures to encourage greater efficiency of log usage are most likely to pay off. THE MAIN POLICY ISSUES AND INSTRUMENTS xix. The approach taken to policy analysis in this study is fairly standard: deficiencies and shortfalls from broad objectives are identified; the roles of major players and interest groups are analyzed; and instruments to move the sector closer to the government's overall goals for it are discussed. The Interest Groups xx. Forest dwelling and adjacent communities: a neglected interest group. The Government's overall target for forest area implies an annual conversion rate of forest of about 500,000 ba, up to the year 2030. Some estimates of deforestation in Indonesia put current rates of deforestation at more than double this amount, but this is disputed by more recent analysis. This review accepts a deforestation estimate in the range of 600,000 to 800,000 .ha p.a. at present. However, it also argues that unless more is done to effectively engage forest dwelling and adjacent communities in management of the permanent forest estate, future conversion is unlikely to occur where it is intended to occur, and degradation of forest areas -even if not to the point of deforestation - will compromise the resource outlook significantly. xxi. This leads to a central tenet of this review: at present, a significant level of displacement of forest dwelling or adjacent communities is arising as a result of the implementation of large scale extraction and plantation projects in Indonesia. The evidence for this is compelling, but anecdotal. The scale of the problem - or indeed of the population falling into the category of directly dependent on tbe forest - is not known. However, it can be argued that neither the programs of the Ministry of Social Aff~irs, nor those introduced by logging and Hrl operators under Ministry of Forestry gu,iQelines, are currently adequate to deal with the problem. However, some improvements could be made within the framework of current laws and policies. Proposed forestry developments could be made subject to adequate notification of communities likely to be affected, and measures taken to elicit a response from those communities. Where they have long- standing occupancy or use of a given area, they should be offered some meaningful role in its development: in some cases, tenure or rights of usage over designated areas wiii be most appropriate; in others, investment in communities specifically to encourage their participation in long tenn resource management (or, in some cases, to build viable alternatives to encroachment) will be more effective. (X) xxi;. Where investment in participation is· indicated. the matters of funding and disbursement arise. Thi:; review proposes a fundmg mechanism to promote alternative income generating investments for forest commumues. Since offering affected communities a share in concession (or plantation) operations also involves funding (albeit via a different route), it" would be ·logical to combine the role of consultation with communities with that of determining the most appropriate solution in one initiative, based around a community development fund, to be financed from natural forest revenue collection. xxm. The role of the private sector: a potentially powerful ally. The other major interest group in forestry is the private sector. It is involved in extraction and processing of the resource, and corporate linkages between these two phases are very strong. It is also heavily involved in the plantation sector, and in this review the plantation sector is considered together with the natural forest management sector, because, again, corporate linkages between natural forest concession operations and plantation investments are strong, and there is also a common locational link. xxiv. The challenge for Indonesia is to harness the considerable energies and financial power of the private sector to the task of sustainable forest management, without r~ucing the vigor of the sector. The two largest chapters in this review examine the areas where Government and the private sector interact most intensively: operations in the natural forest, plantation investment, and processing. xxv. The other levels of government. It is apparent that at present, regional and provincial governments receive relatively little from the proceeds of forest operations, and even less where conservation or preservation of forest areas is concerned. Some local governments in areas where the adverse impacts from earlier deforestation are apparent are willing to take action on their own behalf to ameliorate such impacts. However, others do not yet perceive this problem in their areas, and included in this group will be those with large areas (up to 60 or 70 percent of total land area) of forest remaining. Unless such governments are given some incentive to assist in the process of sustainable management of the resource, they can be expected to use all means at their disposal to promote conversion of forest areas. It will be argued extensively in this report that more revenue could, and should be raised from natural forestry production in Indonesia. Obviously, this has important implications for diverting greater funds towards local and provincial governments in pursuit of better implementation of sustainability objectives. xxvi. Broadening the use of the Reforestation Fund. One means of financing improved arrangements for both forest dwelling and adjacent communities, and provincial and local governments, would be to utilize large surpluses which are building up in the Reforestation Fund. Recent newspaper articles in Indonesia suggest that this Fund, which is formed from levies on logging concessionaires (the Dana Reboisasi) now contains some $900 million in accumulated funds. If current levels of output from Indonesia's forests are maintained (for some time, at least) then this fund will grow at around $400 million per annum. It is most unlikely that this amount of money could be spent effectively on plantation activities alone (its ostensible purpose) and, if it were disbursed to plantations alone, oversupply will be the probable result. This report expresses the view that the Fund should either be returned to the management of the Ministry of Finance (i.e., to become part of regular budget outlays - some of which may well be to subsidize plantation operations, if the Government assesses this as a high priority objective) - or at least should be disbursed against a much wider range of purposes in the forestry sector, including community development and local government support for sustainable management. Establishin!! a fully functionin!! lo!! market xxvii. The overriding objective of sustainability in natural forestry, and that of development of competitiveness and efficiency in processing, converge in the functioning of the Indonesian log market. Presently, large domestic processors receive three types of protection in the domestic log market: • High export taxes on logs cause all log supply to be directed to local processors; (xi) • High export taxes on sawn timber.restrict log supply to exporters of plywood and secondary processed materials (this issue is dealt with under the section entitled The Choices in Trade and Processing below); • Linkage of award of concessions to investors with large processing capacity constrains the development of smaller processors, and limits the development of an efficient internal log market. xxvili. Some analysis presented in this review shows that the current average fee paid for standing timber in Indonesia - around $22 per cubic meter - is well below the international parity stumpage for raw material of this type: this is the expected result from application of the policies described above. Undervaluing the resource encourages waste of the raw material, at a time when limits to its availability are becoming more apparent, and removes a potent efficiency mechanism from the processing sector: processors are not required, for the most part, to compete on a price basis for their raw material supply. The government has a major role to play in ensuring that the log price mechanism is allowed to play its full part in determining efficient and sustainable allocation of the forest resource in Indonesia. There are several mechanisms (not necessarily mutually exclusive) which could be applied to this task: • In purely economic terms, the first best approach would be to re-open the log market to international purchasers. While this approach would probably not be introduced immediately in Indonesia, for largely political reasons, it should not be discounted as a possibility in the longer term: if, by some specified target year (year 2000 may be a logical choice, since this is the year by which Indonesia intends to achieve sustainable management of its production forest resource) progress with raising price competition in the domestic log market is judged unsatisfactory, then a partial or complete re-opening of the log export market could be implemented; • Much of Indonesia's forest production resource is already under concession allocation. However, some concessions are approaching renewal date, and presumably some areas currently under concession will be canceled for reasons of breaches of sustainability guidelines. Also, some new concession areas (in Irian, particularly) remain unallocated. These resources could be offered for sale under the auction or tender process, where sufficient regional competition is judged to exist. It should not be assumed, a priori, that an auction system will necessarily produce better price and allocation outcomes than administered pricing. In this case, careful analysis of vertical integration and corporate concentration would be needed before committing to the system; • The policy instrument most immediately applicable to most of the production forest resource is administratively based standing timber fee rises. Many of the price efficiency effects of opening the log market to export, or auctioning the resource, could be emulated by a systematic series of fee rises, calculated to achieve international parity stumpage (or a level reasonably close to it) by a given target year (again, year 2000 would be logical). xxix. The above options could be applied jointly or separately. The final option, as suggested, is probably the most applicable immediately, since it is within the reach of existing policy and practices. This review argues that the Government of Indonesia should announce its intention to collect standing timber fees according to a schedule which will bring fees to 75% of international parity stumpage by year 2000. The other options could be applied in special cases, or on a more extended time frame basis, depending on the success of administered fee rises. xxx. There are two reasons for suggesting a phased, rather than an immediate rise in log prices to parity levels: (xii) (i) some analysis made in the report suggests tl:.at much of the excess rent is presently absorbed in inefficiencies in logging and processing, not in windfall profits. Under such circumstances, it would probably not be politically feasible to adjust prices up to international parity in one step • some time for adjustment will be needea; · (ii) if prices were raised precipitously in advance of establishment of effective systems to track log movements and gather revenue, increased Jog theft and probably increased carelessness in logging operations as concessionaires seek to maintain profit levels, would result. Since full establishment of improved systems will take some years to introduce, a phased rise in prices is preferable. The Choices in the Forest xxxi. Managing the natural forest resource sustainably, according to guidelines established by the International Tropical Timber Organization will represent a major departure from what has occurred in Indonesia in practice in recent times: much logged over forest has been converted to other uses in the past twenty years, but this would no longer be possible. Therefore, major institutional and policy changes will be needed. xxxii. The concession system. Indonesia presently operates its natural forestry program on the concession system, whereby a license to extract logs over a given area is given to a private sector operator, for a fixed period of 20 years under current rules in Indonesia. XXXlll. This system is highly human resource intensive: all logs must be marked for felling, measured and graded for revenue purposes. Logging operations are managed under a heavy load of regulation, with few effective incentives for good practice, or disincentives for poor practice on the part of concessionaires or forestry field officers. xxxiv. Introduction of the auctioning or tendering system, discussed earlier, would automatically reduce the load on the regulatory system. Under the tender system an assessment of standing volume is made, and standards for the regenerating stand are established; the intermediate supervision required is lessened considerably. xxxv. Even if auctioning per se proves infeasible, alternative methods of pricing and sale of logs can still be applied. Sale of standing timber volume by area can achieve similar objectives: essentially, an assessment of volume on a given area (either the whole concession, or smaller areas) can be made, and area parcels equivalent to annual log volume requirements then defined. Once an allocation is made, the operator is free to extract as much volume as possible, within the sustainability and regeneration standards applied: the regulatory agency is not required to measure output, since the charge is levied on assessed volume. xxxvi. This study proposes that, even within the existing volume based concession management system, a number of major improvements could be made in Indonesia: • The polycyclic logging system (the norm in Indonesia, which stipulates logging of trees from an area down to a fixed girth limit with the intention that trees below this limit will form a second crop in 35 years) may be inferior to a monocyclic system (which calls for removal of all commercial logs from the stand - but retaining shelter and seed trees - and no further logging for 70 years, at which time seedling-based regeneration should be mature). The monocyclic system reduces areas Jogged, raises yields from such areas, and demands something less in the way of control over logging operations. This study does not advocate wholesale transfer to the (xili) monocyclic system, but recommends greater flexibility in silvicultural approach, with more authority being devolved to local officers to decide upon the best regeneration strategy. • This study suggests a number of technical and policy changes in concession management for consideration: license periods (currently 20 years) should be made indefinite, with rolling renewal every 5 years - so that concessionaires have an incentive to commit to an area for the long term; the present plethora of concession rules and regulations should be streamlined; and lines of accountability and responsibility for administering these among provincial and regionalized central government officials should be clarified. Given the current confusing state of definition of forest boundaries and (as noted earlier) of resource information, a re-drawing of concession boundaries and agreements, under an initiative already being explored in Indonesia, is necessary. _ Some improvements in the management of logs after felling - particularly in control systems and royalty assessment and collection, are necessary. • Although Indonesia is working on improving compliance with sustainability conditions in forest operations, and has recently levied heavy fines and license cancellation on some operators, current field capacity to make major improvements in this area is very limited. In the long term, this requires major institutional and human resllurce developments, as discussed the final section of this summary. But this review suggests that, given the importance of improving sustainability in forest usage, an interim measure should be taken. Establishment of a highly qualified, mobile, and independent inspection service is suggested. This service would randomly inspect field forestry operations throughout Indonesia, for compliance with sustainability guidelines. The performance of both logging operators, and forestry agency field staff, would be under review. Although primarily educational in nature, the service would need to be given various powers to exact penalties, or at least report to some entity capable of doing so. Its ultimate purpose is to promote needed attitudinal changes on the part of concessionaires, and forestry field personnel. • One further instrument suggested in the review (for use by an inspection service, or more generally in forestry regulatory agencies) is the introduction of a performance bond premium into log prices, whereby concessionaires would pay an additional amount for logs, which would be rebated on evidence of good logging operations and post logging treatment. xxxvii. The study cites some figures which show that, apart from the environmental and non-wood product benefits to be gained from better natural forest management, there are also significant potential gains in log yield from given areas to be had, if operators are given the incentive to follow better management practices. xxxvw. The plantation subsector. Indonesia is pursuing an ambitious plantation program, both in degraded and denuded areas out of the forest zone (the Regreening and Critical Watersheds programs), and inside the forest line (the HTI program). These programs are financed through the reforestation fund, which is formed from a levy 1 of $15 per cubic meter (recently raised from $10 per cum) of natural forest logs extracted. By far the largest proportion of this money is committed to concessional financing of private sector pulpwood investments under the HTI program. • Some basic economic analysis of plantation options in Indonesia in this review shows that, from the national and global viewpoints, plantations in denuded or degraded areas will retum greater benefits than replacement of logged over forest capable of regeneration, because of large differences in the quantifiable environmental benefits. • The calculations· show that, in theory, the private sector would be indifferent as to a choice between these locations. In reality, -establishing plantations in logged over areas is preferred, (xiv) partly because of proximity to existing concession operations but, much more significantly, because of rights conferred on the concessionaire under the HTI program to acquire remnant logs from the natural sites as interim supply for pulp operations, at a very low resource price. This, combined with Government planting sub~idies (via interest-free loans), makes the HTI an extremely attractive option for the private sector. • There are some technical problems associated with the HTI scheme as presently practised. The selection of sites (which seems to include at least some areas potentially regenerable to effective natural forest cover), and the processes for environmental and technical clearance, are in need of review. xxxix. In this study, it is argued that concessional financing under the HTI scheme should no longer be necessary to attract pulpwood investors. There are potential environmental hazards involved in leasing large areas of hinterland natural forest area to pulpwood HTI concessionaires as an interim supply base and this practice should cease. If financial inducement is necessary and justifiable at all in the plantation sector, it would only be so for encouragement of plantations on open sites (or sites which will respond to rehabilitation under plantation) where the gain in environmental benefits, from the national point of view, exceeds the cost of subsidy. Such inducements should only be considered after more standard government assistance in the areas of research, guarantee of tenure and so on, is provided. xl. Whether the HTI scheme as presently designed will lead to oversupply is moot at this stage: most pulpwood investors are connected to large pulp manufacturing developments, and the viability of these will clearly be dependent on developments in the international pulp and paper market. This is discussed in the next section. The Choices in Trade and Processing xli. Indonesia has followed a deliberate policy of raising local value added in forestry output since the early 1980's: a ban on log export (subsequently replaced by high export taxes); direction of Jogging rights to concessionaires with strong connections to processing (particularly in the plywood sub-sector); a ban (subsequently replaced by high export taxes) on export of sawn timber (intended to encourage further processmg of sawn material); tariff exemptions on imports of certain capital equipment in the proceeding sector; tariff protection on some paper products. Assistance to the private plantation sector (discussed above) also comes into the category, since the intention is to provide a low cost resource for local processors from the package of measures adopted. xlii. These measures have bad strong impacts on both resource usage and the industries that have developed. This form of intervention has involved the government in some second-guessing of the international forest products market, since the product mix emanating from the Indonesian sector has to a significant extent been defined by the policies applied. • Whatever the merit of the original arguments advanCed in favour of promoting value added (and some of the trade and market assumptions inherent in these arguments are discussed in this review), it is argued here that the priorities for Indonesian processing are now development of competitiveness and efficiency, probably through increasing diversification of output, rather than rapid capacity growth and pursuit of market share in existing markets. Because of the relative ease of substitution in those existing markets, they are unlikely to produce above-normal returns to suppliers in the long term. • One important new development in international markets is growing consumer resistance to products based on non-sustainable use of natural resources. Whether this is codified through (xv) specific consumer country bans or restrictions, or left to market forces, the outcome will be similar: suppliers who can convincingly demonstrate sustainability will be increasingly favored in international markets, while those who cannot will risk significant loss of market share. • This observation emphasizes an important argument which is implicit in this review: there is a strong connection between sustainability and efficiency in resource usage. Policies which promote output growth at the expense of resource efficiency, or which simply fail to give sufficient emphasis to resource efficiency, run a high risk of unsustainability in a context where the resource base is limited. xlili. The Indonesian plywood sector: a need for efficiency and diversification. Of all subsectors in the forest products sector, plywood manufacturing is the one most favored by government policy. This sub- sector is the principal beneficiary of government policy to direct log supplies to processors, rather than encourage them to compete for such supply. The market base of the sector, although very large in size, is narrow in scope: the great bulk of output is exported as commodity grade plywood, much of which is used for concrete forming and similar purposes. Margins in this trade although relatively high at the time of writing, will tend in the longer term to be low, and it is suggested in this review that most industry profit comes from rents transferred from logging. The market is, by its nature, vulnerable to substitution by other wood products (including softwood), and also to replacement by technological change. Achievement of large market share may therefore be of lower benefit than for other products. xliv. The industry has taken measures to reduce creation of new capacity to very low levels, and thereby control the flow of supply onto the international market. However, this measure will need to be augmented by development of higher rates of technical and economic efficiency, and more diversification into market-grade decorative plys and other products. xlv. The sawn timber subsector: has Government policy gone too far? The sawmilling sector, even prior to export restrictions, had major efficiency problems. It is also apparent that prior to imposition of the export taxes, a significant amount of sawn timber in very large sizes was exported: in effect, this amounted to very low value added exporting that could avoid the log. export ban - allowing processors to capture much of the large rent available due to low resource prices and high international prices for logs and semi-processed material. However, the tax policy as applied may have bad an unintended effect: across the board taxes effectively prevent export of relatively highly processed sawn material (i.e. material with as much value added as plywood) as well as low value added product. Moreover, although the purpose of driving more resourCes into secondary wood processing was initially achieved, the expansion of investment in that sector has now slowed considerably, and it has been suggested that in fact some secondary processing relies on the existence of an efficient sawmilling sector - something Indonesia does not have. Although by no means a first-best solution, replacement of the currently broad based prohibitive taxes with a tax scaled to size of sawn material, or its world price, so that better quality or more highly processed material could still be exported, may achieve a better result. xlvi. Secondary processing: what limits growth? Indonesia appears to have some natural advantages in the area of furniture making, moldings, and woodworking: a basically high quality resource, and a strong base of woodworking craftsmen. But, at this point in time, some of these industries have not developed, while, as noted above, others underwent initial rapid expansion under the impetus of the sawn export tax policy for a period, and then slowed. Some of this effect may be due to the coincidental deterioration of the international economy since the late 1980's, or to the sawmill sector effect discussed above. But it also appears that at least some of the problem is lack of access for these industries (and potential entrants) to raw material supply: certainly, this is a view encountered frequently in the industry in Indonesia. Much of the resource remains under the control of concessions linked to plymill operations. Much of the sawmilling capacity that prior to 1989 bad supplied the export market·is linked in integrated operations to plymills, and (xvi) it appears that a significant proportion of Jog supply from these has been retained in those operations, not released to independent secondary processors. xlvii. Pulp and paper: a high growth'prosped? ·Projections of growth for Indonesia's pull? and paper sector in general suggest rapid expansion: the domestic market is growing quickly and, except for newspnnt and some paperboard products, Indonesian suppliers of this market are pricing competitively at present. Winding down of present tariff levels on paper products is therefore in prospect. In theory, Indonesia can also be highly competitive as a supplier in the international pulp market, and one projection indicates Indonesia may have a 20% share of the global market for short fibre kraft pulp by the year 2005. How profitable this will be to investors will depend upon price movements in this notoriously unstable market. After the year 2000, it is expected that the Indonesian pulp and paper sector will be almost entirely reliant on plantation resources, and it is planned that such resources will come from existing plantation areas under rotation, or from plantings on areas unrelated to existing natural forest sites. It can be expected, therefore, that the impact of the pulp and paper sector on the natural resource will decline over time. Institutional Refonn and Human Resources Development: The Key to lmplementin!! Chan!!e xlvili. Even if Indonesia chose, at a political level, to introduce the challenging policy reform package embodied in the observations and analyses presented in this review, little would result unless the agencies and interest groups involved in the sector accept such change, and are equipped to deal with it. xlix. The final chapter of this review therefore deals in some detail with the practicalities of implementing change. These involve: redefining the mission of forestry agencies and interest groups, in light of Government's broad aims and specific policy changes (when these are determined), establishing linkages between interest groups; and keying human resource development investments to the needs, and structure, that emerge from this process. 1. The basis of change in this area must be improved management of human resources in the sector. Without major improvements in such management, the impacts of policy reform, training inputs, and technological and research developments will be marginal. li. The review provides an analysis of how one of the major agencies in this sector - the Ministry of Forestry - requires radical changes in its approach to managing human resources. It is argued in the review that the conventional approach to institutional strengthening - essentially adding technical assistance, training inputs and some additional tasks or goals to the existing structure - will not work. Strong agency and individual task redefinition is needed, and this will imply structural re-organization, including re-deployment of staff at all levels (central, provincial and districts). Devolution of some functions and responsibilities currently held in the center - a perennial issue in Indonesia, especially in the forestry sector - will also be required. To solve some of the chronic problems of lack of inCentives, rewards and a meaningful career structure which adversely affect performance in the Ministry, as well as to improve flexibility and the skill- mix applied to specific tasks, certain technical tasks should be contracted out of the Ministry: so that interested Ministry staff, in combination with private sector, academic and other interested panies, could combine to bid for, ~d then perform such tasks, thus creating a more effective consultancy market. The implementation of an inspection service, discussed earlier, could be achieved using this mechanism. Iii. Consulting with communities affected by forestry developments is, as suggested above, an increasingly important task in Indonesia. It is also one which requires a broad mix of skills, and ultimately an ability to deliver solutions and investments where they are needed. Forestry bureaucracies have, throughout Asia, proved to be poorly suited to this task. It is suggested, in this review that the solution will have to involve community representatives, or communities themselves, in some functional way and it will also need to operate fairly independently of line Ministry control. It is also suggested that since a funding (xvii) base to finance involvement by communities in forest management (or alternatives) will be required, some initial measures to accumulate some proceeds from enhanced forest revenue collection, and to commence their disbursement, should be taken. 1 CHAPTER I INDONESIA'S ECONOMY AND THE ROLE OF THE FORESTRY SECTOR The Indonesian Economy: History and Prospects 1.1. Recent Economic Developments. In 1967 Indonesian per capita income was $50 per capita: by 1991, this figure bad reached $610, and the number of people in absolute poverty bas fallen from more than 70 million, to about 27 million, over the some period. Table 1.1 presents changes in key macroeconomic variables since 1975, and gives Bank projections for these variables to 2000 AD. Table 1.1: KEY MACROECONOMIC VARIABLES FOR INDONESIA 1! AciUaJ Projecu:d /~ 1975-83 1983-89 1990 1991 1992 1992-95 1995-2000 Average Real Growth Bates (% e.a.) Gross domelllc product (GOP) 6.5 6.0 7.3 6.8 5.2 5.6 5.9 Non-od GDP 7.0 6.5 7.8 6.5 6.2 6.5 7.0 Non-oil expons 10.5 16.9 2.8 24.3 19.1 9.3 7.6 Fixed Investment 10.7 1.3 19.7 10.7 7.1 5.9 7.5 Strucrure of !he Econom31: ('A>} I!!. Non-ot1 manufacwringiGDP 9.9 14.1 14.9 15.5 16.2 18.4 22.8 Non-oil exponslnon-oil impons 37.4 87.9 71.2 71.5 86.5 93.5 97.1 Nattonal Savmgs/GDP 21.0 21.7 22.1 22.2 22.9 24.4 25.6 Fixed Investment/GOP 25.1 21.2 23.5 24.7 25.4 24.9 26.1 Macroeconomic Balances ('A>ll!!. CutTen! account/GNP -7.8 "~. -1.7 -3.8 -4.3 -4.0 -2.0 -2.0 Overall public balance/GOP -4.3 I£ -2.1 -0.2 -0.7 0.0 -0.2 -0.3 MLT debt servtcelexport 17.0 32.3 27.8 30.1 31.9 25.8 19.9 1! Balance of payments and fiscal data are for fiscal yean (starting April 1). 1!!. For lhe last year of multi-year period. I£ For 1982/83. I!! Indonesia: Growth, lnfrastrucrure and Human Resources (No.10470-IND), May 25, 1992. Source: Table 1, Memorandum of !he President 10 Executive Directors for a Third Communtl:li: Health and Nutntion ProJect, World Bank, December 1992. 1.2. These results place Indonesia among the ten fastest growing developing economies in the world. They reflect Indonesia's strong emphasis on macroeconomic stability and diversification through the 1980's in particular, when fluctuating oil prices threatened considerable dislocation. Indonesia has introduced far- reaching reforms in trade, investment, taxation and finance; and these have enhanced the flexibility of factor markets. 1.3. In trade, a shift away from import licensing to tariffs was enacted in the mid 1980s, and the level of tariffs has then been drawn down, from an average rate of 37% in 1985, to about 20% in 1991. 1.4. As a result of these measures, lndone:.ia bas become more strongly integrated with the global ~nomy through its trade and capital accounts, and bas become less vulnerable to external shocks than in the past. Nevertheless, some vulnerability remains, in oil pricing, relatively sluggish demand for Indonesia's non- :>il exports, the downward pressure on the US dollar, and high debt levels. 2 1.5. Future Goals and Prospects. For Indonesia to continue to pursue its long standing development goals of growth, stability and equity two factors have emerged as being critical: quality; and sustainability. 1.6. Quality issues surround the delivery of public and private services in Indonesia, particularly in the area of education and training, construction and management in the transport telecommunications and power sectors. These issues will be addressed by the Bank in the forthcoming Country Economic Memorandum, and the Environmental Management Review. 1. 7. It is clear that growth has in the past been pursued through heavy reliance on natural resources - some of which are now showing signs of stress and shortage. It is also a fact that environmental sustainability in particular will impact upon equity: poor people are more wlnerable to the negative impacts of environmental degradation than other groups. They also contribute to environmental degradation because, lacking capital, skills and (often) security of tenure over resources, they frequently have little alternative to inefficient and unsustainable use of resources. 1.8. The relative share of primary commodities in total GOP in Indonesia bas declined from 60% in 1970, to 39% now, and is projected to decline further to 17% by 2010. The contribution of such commodities to export income has similarly declined from 94% in 1970 to around 60% now. However, in absolute terms, the value added by primary commodities bas doubled over this period, apd it can be expected that their value added will grow by a further 50% by 2010. The Role of the Forestry Sector 1.9. The forestry sector represents a case study of the sustainability issue, raised above, for Indonesia. Forest products have become an important building block for development in Indonesia, and output bas grown rapidly (see Table 1.2): total production from the forestry and forest products sector is about $8 billion, 1 or around 7% of GOP. The value of exports from the sector in 1991 was $4.2 billion (see Table 1.3): about 20% of non-oil sector income for that year. The sector has added importance in that it offers one of the more obvious routes to development of the outer islands of Indonesia: a Government priority, which recognizes limits to growth and development on the already heavily populated island of Java. This possibility arises because the natural forest resource is located on the outer islands (as will be much future plantation forest). It is evident that some large scale industries - especially the new investments in pulp and paper - are already locating on the outer islands, and it is at least feasible for more smaller scale forest processing industries such as moulding and furniture makers to locate there as well, given their relatively low technical and infrastructure demanas. 1.10. 'JPe formal forestry sector employs about 680,000 directly in Indonesia: about 1 percent of the total workforce. About 426,000 are in the processing sector; the remainder in the resource management and extraction sector. Forestry is generally thought to have fairly ~igh employment multipliers, but the main reasons why the above figures may understate the importance of the sector as an employer are: Many people in Indonesia (actual numbers are not available: see paras 3.112 to 3.113) are dependent on some aspect of forest output -especially non-timber extracts - for some, or all of their livelihood. The numbers involved in this informal sector are likely to dwarf formal employment figures. 1 This is an estimate formed from output figures for the various sectors in recent years, with some adjustment for likely underquotiog of output in some sectors. 3 As noted in para 1.9, there is a certain premium on regional industry employment in Indonesia, given the Government's priorities to develop the outer islands, and forestry is one means of providing this type of employment. Table 1.2: CONSUMPTION AND TRADE FLOW OF SAWNWOOO, PLYWOOD, PULP, PAPER & PAPERBOARD IN INDONESIA 1976-1992, '000 TONS OK'OOO M' Product 1976 1980 1990 1992 est Pulp Consumption 20 164 737 1169 - production 1 46 701 900 -exports -imports - 19 - 118 181 217 101 370 Paper & Paperboard Consumption 304 512 1371 1754 - production 62 231 1438 2199 -exports -imports - 242 7 287 190 123 544 99 Plywood Consumption 204 728 1262 1350 - production 214 1011 9503 10850 -exports 13 245 8241 8900 -imports s - - - Sawnwood Consumption 2356 3579 7180 7500 - production 3000 5327 n96 8600 -exports 643 1203 616 1100 -imports - - - - Source: World BankllTI'O Marketing and Deforestation Study (see op cit pg.54). Table 1.3: EXPORTS OF WOOD BASED PRODUCTS BY YEAR, 1985-1991 /§ ISJC (m US$ million) Product 1985 1986 1987 1988 1989 Code 1990 1991 Sawnwood 33111 226 269 398 516 665 100 82 Building materiala/k 33112 126 137 165 193 344 399 586 Plywood 33113 797 951 1,682 1,994 2,352 2,726 2,871 Boxea, containen 33120 2 4 2 13 24 2S 33 Raa.an 33130 8 9 12 18 48 69 78 Funuau:e 33210 7 9 27 70 144 236 313 Paper 34111 26 29 90 109 152 178 239 Total 1.192 1,414 2.376 2,973 3.729 3,733 4,202 I§ Covers only large (100 or more employees) and medium (20-99) scale establishments. fh Includes parquet, joinery and carpentry of wood, doors, window frames, sleepers, etc. Source: Central Bureau of Statistics. - 4- 1.11. While forest use is important to .economic growth, and may have a sig..Uficant role in government objectives ~o decentralize and further diversity the economy, the natural forest is a finite resource, and there are also natural and economic barriers to expansion of plantation resources. In addition to pressures being placed on the forest resource through official government programs of conversiop, there are pressures from forest dwelling and adjacent populations, who, under certain population and income conditions, use the forested areas in an unsustainable manner. 1.12. Eventually, the cumulative effects of pressure on the resource will compromise the ability of the ecosystem as a whole to maintain its balance. Once certain thresholds of depletion or degradation are exceeded, the sustainability of the ecosystem is lost. In the case of forest, which covers most of the land area of Indonesia, the costs of such losses will probably be greater than the direct economic activities based on the resource: very large watershed and soil quality functions are performed by the forests of Indonesia and these are of vital concern to the enormous rural population - and, in the case of water values, also to the rapidly increasing urban population of the country. In recent years, the global values of the forests - their ability to store carbon; their major (and as yet not fully evaluated) role as barbo~rs of biodiversity - have also gained considerable force and recognition. A detailed discussion of these issues will appear in the Bank's forthcoming Environment Review. 1.13. Supply and demand projection. An initial quantification of what may be possible, in terms of supply of wood resources, bas been attempted in recent years, and is displayed in Figure 1 below. A range of projected demand is overlaid on this figure. Figure 1. Mlll.m3/a 200.-------------------------------------~ -il- High demand ..... Low demand IITlll Home gardens 188 Estate crops ~Plantation pulpwood II Plantation logs ~Conversion cut • Selective cut 20 0 1990 1995 2000 2005 2010 2015 2020 2025 2030 Source.: ITFAP (u• op cit pg 7) WCIItd BenkiiTTO Study C... op cit pg !54) 5 1.14. These figures suggest that, if the low demand estimate made in the ITFAP study eventuates, then the supply of wood forthcoming (assuming both estate crop and tree plantation developments as forecast eventuate) would exceed demand: balance would, be attained if demand is 10 - 20% higher. It is difficult to be any more precise that this: in the international market, tlie behavior of other suppliers (Malaysia, but also suppliers of potential substitute materials such as softwood- i.e. Pacific rim suppliers, and potentially Russia) is unpredictable. So too is the behavior of international consumers: see paras 4.14 to 4.21 for a particular environmental issue in market development. As another example: even though tariffs on finished forest products in Indonesia's main market countries are relatively low, their complete elimination would allow f.o.b. Indonesia prices to rise significantly, and pressure for a new demand equilibrium would arise. 1.15. On the· supply side, sources of uncertainty are, if anything, even greater: the real capability of the natural forest to produce log volume in the long run is not precisely known, both because areas of forest actually accessible and suitable for production cannot be precisely estimated (see chapter m. and because the growth rates of commercial trees (itself a variable group of species through time) in Indonesian natural forests is also not yet known with any precisiotl, and will not be until inventory- and yield data currently being compiled are available. Moreover, as will be examined and greater depth in Chapter m of this review, the options for greater unit efficiency in use of available resources, and the economics of plantations as a supplement to natural resources, are both areas of considerable uncertainty at present. 1.16. The most common view on future demand supply balances from the South East Asia region in general, is that some price rises for forest products will result primarily from developing shortages of high grade tropical logs from traditional suppliers (Malaysia and the Philippines), but that these rises will be tempered by temperate zone substitutes (hardwood and softwood). 1.17. Assuming that Indonesia wishes to remain a significant forestry nation in the long term (see para 1.18), its success in so doing will be determined by its ability to produce the required raw material resources on a continuous basis, and to efficiently transform and market that material as forest products. ·1.18. Indonesia's commitment on sustainability. The Government of Indonesia is committed to sustaining large areas of its forested area under forest cover, either for preservation or long term production purposes. Clearly defined target areas for conservation, protection, limited production, production and conversion forests are set out in various government planning documents. In the Government's forestry Action Plan2 , it is projected that by 2030 AD 84 million hectares of natural forest will remain in Indonesia (compared to an eStimate of 107.5 million ha for 1990 in the same publication): the residual 23 million hectares is intended to be converted to agricultural and plantation uses. Of the total forest area, some 53.4 million ha is expected to remain as conservation, protection or unclassified forest, while the remaining 30.6 million hectares is intended for sustained production use - i.e. it is expected that by that date, no further natural forest conversion will be taking place. A much larger role for plantations in total wood supply is foreseen (see para 3.80). 1.19. If Indonesia is able to retain such an area under natural forest by 2030 AD, and to manage a significant proportion of that resource under genuinely sustainable production management, this would represent a very significant achievement economically and environmentally, unmatched in recent decades in other tropical forest countries with large resources. Certainly, it would in the eyes of most reasonable observers amount to fulfillment in the forest area of Indonesia's commitment to manage its environmental resources for the benefit of mankind, as expressed by President Soeharto: "Together with our long seashore and the rich contents of our equatorial seas, our forests also constitute a source of biological diversity important for all life on Earth. The position of l Ministry of Forestry, 1991, Action Plan for Forest Sector Development in Jndone5ia 6 Indonesia, situated between two continents and two oceans, provides us with environmental riches which are very significant for the survival of mankind. That is why we have a responsibility for the global environment". 1.20. The Government of Indonesia recognizes that the country's success in sustainably managing the natural forest resource will also be crucial to development of market strength and industrialization. In his address of state delivered in Jakarta on 15 August 1992, President Soeharto stated: "Our industrialization is one that does not destroy natural resources but preserves the quality of the environment ..... We have to encourage and develop industries which are capable of producing better quality goods with higher value added, which are not wasting natural and energy resources". 1.21. The Government of Indonesia has codified its approach to sustainable forest management incorporating both the productive and protection goals, by getting forth the goal to implement guidelines issued by the International Tropical Timber Organization (see Box.l.l) by the year 2000. The liTO guidelines provide a framework for introduction of genuine sustainable management, albeit that there are widely differing opinions in the economic and environmental communities as to what should be sustained, and bow this should be done. Some discussion of forest sustainability, extracted from a forthcoming World Bank publication on forest management, is given in Annex 7. The problem, in essence, is that some inte~ groups argue that sustainability can only be achieved by preserving the full range of ecological assets across the broad base of the remaining resource. Clearly, this precludes any significant form of timber extraction, and in fact would preclude extraction of some other forest products as well. Whilst it is a reasonable criterion for areas selected for preservation, it is inapplicable where significant wood and other production is intended, as is the case for the resources of central interest in this review. Even if a less demanding definition, which allows for timber and other products extraction, is allowed, there re~ain differences between those who argue that annual output should not ever exceed the capacity of the forest to regenerate in that year, and those who suggest that, particularly where 'overmature' forest which is not growing is present, 'pulse' harvesting of much higher amounts may be acceptable: in effect, they argue, the objective over the long term is to have effectively regenerating forest over the designated forest area. 1.22. This review takes the view that the latter, 'economic' view of sustainability would be acceptable for production forest areas, so long as the realities of long term resource management are home in mind. It must be recognized that if the result of 'pulse' harvesting at some point in time were to be a very large area of immature regeneration and little available mature resource, then the resource would be most unlikely to survive to a second cut. Neither the processing industry (which would, at that point, cease to exist and presumably would have factored such an outcome into its final years of operation) nor the government (which faces a sustained period of zero revenue from the resource) could be expected to take much interest in its protection, and spontaneous conversion would be the result. Thus, some continuity in actual, as opposed to potential, resource flow from the forest will be necessary to givt: the natural vested interests reason to take a sufficient part in its survival. Thus, whilst "annual allowable cut" may need to vary to some extent to allow for both resource and market variability, some concept of a continuous resource flow should remain in management prescriptions. The ITIO guidelines serve this purpose. 1.23. The liTO guidelines have the added advantage of being supported by the powerful private sector in Indonesia. The Concession Owners Association of Indonesia (APHI) is supporting the operation of a recently instituted steering committee, which has been charged with the responsibility for converting the liTO guidelines into specific criteria for evaluation of sustainability in forest operations. 1.24. Even when guidelines are available, however, there will clearly remain difficult decisions as to where the lines between production, protection and conversion forest should be drawn. In Chapter n, some of the difficulties and uncertainties involved in this are discussed. Then, it will be argued in Chapter ill of this review that setting this balance will remain largely a political decision in Indonesia albeit that economic, social and environmental analyses can assist. 7 Box 1.1: SUSTAINABLE MANAGEMENT, AND THE ITIO GUIDELINES An expert panel appomted in 1991 by the International Tropieal Timber Organization (ITTO) defined sustainability as the production of a continuous flow of desired forest products and services without undue reduction of its inherent values and future productivity and without undue undesirable effects on the physical and social envllOnment". The ITIO guidelines for the sustainable management of natural forests by the year 2000 includes 41 principles, among them the following: • A strong political coiDDUtment to sustainable management, supported by appropriate legislation and in harmony with other sectors, is needed. • Some categories of land need to be kept under permanent forest to secure their optimal contribution to national development. These include protection forest, lands for nature conservation and for production of timber. Production forests should fulfill other important objectives, such as environmental protection and conservation, ecosystems, and be subjected to a detailed inventory. • • Proper planning at the national, forest management unit, and operation levels is an essential component of sustainable forest management. • The choice of silvicultural practices should be aimed at sustained yield at minimum cost. A reliable method (such as the annual allowable cut) should be adopted for controlling timber yield. • An environmental impact assessment should be done prior to harvesting. Care should be taken to minimiu: logging damage to the residual stand. • Concessionaires should be assured of the long-term viability of their concessions; local populations should benefit from forest management; and governments should receive sufficient revenue to continue their operations. • The success of forest management for sustained timber production depends on its compatibility With the interests of local populations. Local people should be consulted before planning any forestry operation. • The management of timber production can only be sustained in the long-term if it is economically viable. In enunciating these principles, it has been recognized that in many countries, logging practices, timber pricing policies, and wood processing incentives have encouraged rapid depletion of the natural reSource and contributed to "unsustainable development". Source: Emmanuel D'Silva and others, 1993; Forestry Management for sustainable Development; An EDI Seminar Report; World Bank, Washington (forthcoming). 1.25. The Government acknowledges that serious problems exist in sustainable management of the natural forest at presentl: "At the projected annual average production of 31.4 million cubic meters during Repelita V, some of the natural timber stock could survive well beyond 2050. But deforestation, wasteful logging, the practice of high grading, fire and other factors will affect the growing stock adversely. Due to population and industrial growth, the projections suggest that the raw material situation will become critical in about a decade if Indonesia continues to maintain its Indonesta Tropical Forestrt Action Programme (1992}, Country Brief; Ministry of Forestry of Republic of Indonesia. 8 market dominance and industrial pace, and its forest resource management and utilization efficiency do not significantly improve". A Comprehensive Approach to Indonesian Forest Sector Strategy 1.26. Before considering the building blocks of a new strategy for forestry, some consideration needs to be given to the choices Indonesia has made in the past, and those it faces in the future, in the forestry sector. 1.27. It is reasonable to divide policy initiatives over the recent decade in the sector into two groups: • Policies aimed at promoting industrial development based on the resource, via directed concession grants, and trade policy. • Policies aimed at conversion of some forest areas in favor of agriculture and tree crop development - much of this being associated with the relocation of people from Java to the Outer Islands. 1.28. There were compelling reasons for Government's use of these directive, interventionist policies at the time of their introduction: a shortage of entrepreneurial talent in the country; a shortage of risk capital in the private financial market; an underdeveloped land market. The first two of these problems are very much on the wane in Indonesia; the matter of land remains a vexed question, but certainly not one beyond the capacity of Government to resolve by implementation of some major policy changes, and investment in a major titling exercise. 1.29. At this point, as Indonesia enters its second 25 year planning period, it faces some of the more sophisticated and difficult issues of an economy which has made many of the primary gains of development, and now m\lst consolidate and deliberate upon directions to follow from here on. In the context of the forestry sector, some major questions arise in this context: • Are the developments in progress on forest land - still the major land base in Indonesia - economically and environmentally sustainable? That is, are the realized demands being made upon this land base - by log extraction operations; official conversion programs; unofficial (but, under the circumstances, inevitable) conversion - reasonable, and compatible with broad environmental caution? • Are the procedures and mechanisms under which the sector now operates compatible with Government's primary objectives on poverty alleviation and equity- given that large numbers of Indonesia's poor live in, or near forests, and depend on them to some extent? 1.30. Were Indonesia able to fully answer these questions, and to produce, and implement, comprehensive and consistent polices in response, then answers to subsidiary questions (such as: who should own the forest? what should the price of the resource be? how much investment should occur in plantation and natural forest management? how should the process of resource usage be made more transparent and responsive to public demand?) would arise as a matter of course. They would be the consequences, not the elements, of rational strategy. 1.31. This review takes the view that, whilst a comprehensive strategy to deal with these issues could be articulated in Indonesia, implementation will require more focus and prioritization, even in the longer term. The following paragraphs set out some short and long term objectives which would, if pursued, set the basis for a sustainable and equitable approach to use of Indonesia's forest resource. The remainder of the review details an analysis of the existing situation in the sector, and refines the focus further to some immediate policy and institutional changes which are required, as building blocks for a long term strategy. 9 1.32. Establishing a fully functioning log market. In terms of revenues flowing to resource owners (as represented by the Government oflndonesia), it will be made clear in subsequent chapters that the natural forest resource in Indonesia is significantly undervalued in the log market. Prohibitively high log export taxes reduce effective demand for logs, and strong linkages betw.een logging concessions and processing firms further inhibit the entrance of new potential log purchasers 'into the sector. Various defenses and rationales for such policies have been advanced in Indonesia (and elsewhere) and these are examined in subsequent chapters. Certainly, such policies did lead to creation of a large domestic processing sector. In the long run, however, it is evident that the resource should be allocated (within the biological limits set by sustainability objectives) according to price, so that what is extracted goes to the highest and best use. The objective now must be to promote competitiveness and efficiency in processing. It would be a reasonable objective for GOI to target collection of all available economic rent from the resource by year 2000, as determined by international parity prices for the raw material. This would impose some structural change on existing processors, and would open the market. to new entrants, including small scale, localized entrepreneurs presently prevented from access to raw material resources. 1.33. In the short to medium term, there are some structural and political reasons for believing that a re-opening of all or part of the Indonesian log market to foreign purchasers may not be feasible. In the longer term, however, this must be retained as an option by Government. It would in fact be lcgical for the sustainability year of 2000 to be also used as a date by which to review the export taxes on logs, so that if domestic processing has not by that time made the necessary efficiency adjustments to be able to purchase logs at (or near) international parity prices, then sales to external purchasers could resume. Such an approach would form a reasonable compromise: between the one extreme of introducing international log parity prices immediately (which, apart from the obvious political and social consequences this would have may eliminate the value of significant sunk capital in operations which are, potentially competitive and efficient); and the other extreme of doing so little in introducing market signals into the sector as to institutionalize rent-seeking at the expense of development of competitiveness and efficiency. 1.34. Higher log prices could be achieved via auctioning of timber rights, in cases where existing concessions are expiring, and an effective and competitive market for the resource exists. In other cases, where long term concession rights are in place, or an insufficient number of effective bidders exists in a given region to ensure genuinely competitive auction prices, the Government could set log prices according to residual-appraisal formulae calculated from international f.o.b. price levels. By phasing in the transition to such pricing strategies over a time period, following firm policy announcements, Government would allow existing industries time to restructure, and would encourage potential new investors to begin seeking log supply sources prior to investing in new processing capacity. 1.35. This would set the groundwork for an efficient, competitive log market, which in tum will produce the optimal concession system for Indonesian natural forests. Elimination of excessive rent-seeking in the concession licensing system will allow for more flexibility in allocation of ownership or leasing rights over forests, and in the introduction of multiple uses -including the full range of biodiversity conservation, eco-tourism and other global considerations - into forest management agreements. The resulting system of forest management would in all probability blend auctioning (or other forms of sale) of timber extraction rights to interested purchasers, and rights and/or contracts of management to other interest groups (which might include local communities (with the rights or otherwise) and provincial governments) - aU in the context of a firm government policy on the broad parameters of natural forest conservation. 1.36. By firmly estaplishing such principles for use and conservation of the resource, many inefficiencies and inflexibilities in the current forestry sector will be eliminated: new forms of processing, and new markets will be pursued where these show promise of higher gain; and the debilitating aspects of the nexus between logging and processing operations would be broken: partnersnips would still be possible, but only on the basis of efficiency and profitability. As normal profits replace windfall levels in the logging sector, practices such as cross-subsidizing relatively inefficient processing from proceeds of the logging operation would become untenable. An appreciation in policy formulation of the real underlying values of the forest - and a more equi-table distribution of these values - would become a more routine matter. 10 1.37. Involving regional governments. One aspect of distribution of revenues which needs review in Indonesia is the share of forest revenues received by provincial and local governments. Presently, these entities receive a minority share of the IHH (royalty) component of total fee collections: and the IHH is itself a minority proportion of total fee collection - about $7 per cum, out of an average fee of around $22 per cum at present. 1.38. In the past, this division may have been more appropriate since it is evident that much of the forest area logged over has in fact been converted to other uses, in which regional governments participate more fully. Now, the priority has changed: the great majority of forested area remaining is intended for retention as forest - either for sustainable production or various conservation purposes. Local and regional governments, however, can only be expected to support this approach if they receive a reasonable proportion of the proceeds from sustainable use. Nor should this allocation be made on a production basis, since it is as much a goal of policy to retain and protect conservation areas, ·as sustainable production areas. The allocation from revenue to local and regional governments should therefore be made on the basis of permanent forest area (regardless of its use category) - weighted to some extent by population levels, to account for the fact that jurisdictions with high population levels in a near forests will need to invest more in programs devised to offer realistic alternatives to encroachment. Local and regional governments would then be expected to support sustainability: to refrain from pressuring for conversion of areas designated as permanent forest, and to work with central government on program to encourage forest dwelling and adjacent communities to participate in sustainable management. 1.39. It is suggested here that a much higher proportion of forest revenues should go to local and regional government. If fee collections rise according to recommendations made in this report, then allocation of 40-50% of the total to local and regional government would be feasible, without prejudicing amounts going to central revenue and reasonable allocations to plantation purposes, and community participation (some of which, as suggested above, would naturally be funded from local government sources). 1.40. Managing for sustainability. The main task for government forestry agencies, under the strategy outlined above, would become one of ensuring that acceptable environmental and utilization standards apply in field forest operations. This is already an objective and, as will be examined at some length in subsequent chapters of this report, there are already major technical and institutional problems in this area; both in the definition of acceptable standards of sustainable forest management, and in the enforcement of those standards. These will be accentuated, because as natural forest stands become more inherently valuable, incentives to avoid revenue payment (by illegal removals), or to raise returns to logging via lowering operational standards in various ways will increase. 1.41. Two important and related policy implications arise from this. First, the matter of independent audit of forest operations, to ensure that both operator and forestry agency field staff performance reJI!ains satisfactory, becomes of primary importance: government must. be prepared politically not only to invest significantly in establishment of such processes, but also to pursue the application of disincentives and penalties vigorously. It will be in the interests of government and the private sector alike to ensure that such processes are linked to developing international initiatives on certification of sustainably extracted timber. 1.42. The second issue is the nature of forest extraction agreements (whether in the form of concessions, auctioned timber rights or other mechanisms). There is already considerable activity underway in Indonesia on the re-definition of production forest boundaries, and the quality of management plans for use of such areas. Considerable policy development work remains to be done, however, to ensure that all parties involved agree on boundary definition and take sufficient action to implement this, and on broad implementation and enforcement of forest management plans. The relevant issues on this matter are discussed in Chapters ll and ill. 1.43. A plantation policy to enhance sustainability. It will be argued later in this review that in practice, GOI plantation policy and incentives may have led to destruction of regenerating natural forest areas. If plantations are to genuinely reduce pressure on the natural forest resource, then implementation of stronger 11 policies will be necessary. In the short term, GOI should announce that the practice of allocating large areas of natural forest to a pulpwood plantation concession (so that an interim supply of natural forest pulpwood is available) will cease: from now on, any prospective pulp and paper manufacturing project should be required to generate pulpwood supplies from plantation:on.··geouinely open areas. The lead time for planning, construction and commissioning of a large scale pulp and paper making operation should be sufficient for a plantation resource to be grown to pulpwood size. 1.44. In the longer term, consideration should be given to elimination of subsidies to plantations in Indonesia, specially in the case of fast growing pulpwood plantations by large industrial concerns. One important element in this will be price developments in the natural resource, as discussed in paras 1.32 - 1.36 above. If neither high grade (sawlog and veneer log) nor lower grade (pulpwood) material is available from the natural forest area at prices below real market value, then the value of plantations will also rise, and the need for subsidization to attract investors will be reduced. 1.45. Equity, poverty alleviation and participation. The policy measures discussed above relate primarily to the role of government in efficiency and technical aspects of managing the natural resource for sustainability. It is unlikely that such policies will succeed, in Indonesia, without corresponding changes in policies and attitudes towards the people who live in, or near, forested areas, and who derive some significant part of their livelihood from such areas. 1.46. Both GOI and the Bank now have poverty alleviation in primary place among their objectives. In the forestry sector, it is evident that a large number of people currently dependent on forest areas for a significant part of their livelihood, are living near, or below, the poverty line. Certainly, these communities are among the most remote and poorly serviced by existing public institutions in Indonesia. Such people can be (and frequently are) made worse off by official forestry developments in which they rarely are offered any share, and through which they may lose access to benefits of forest use (whether of an historical and traditional nature, or of more recent origin). 1.47. Although some recent legislation and policy changes in Indonesia formally improve recognition of some traditional community rights in forestry, in practice such communities are usually regarded by forestry · agencies and industry as a problem, rather than as part of the solution. Smne exceptions exist: there are experiments current in Indonesia on community management on forest concession areas; and some concessionaires have made genuine attempts to initiate long term development project on behalf of affected communities. However, these are non-systemic, ad hoc events. 1.48. There is more than equity involved here: although no precise estimates exist, the numbers of people directly dependent to some extent on forests, and affected by forestry developments, is large. They remain in such areas when logging activities have closed, and they area a potent force for destruction of regenerating areas, if offered no alternative. 1.49. Eventually, Government in Indonesia will need to give due recognition to title and rights of local communities in forest areas, and on that basis to establish formal and effective processes of consultation, prior to initiation of forest operations. A necessary first step towards this objective would be to promulgate regulations giving implementation to recent legislation which recognizes some community rights in forest areas, and sets up administrative appeal processes. Design of such regulations should be done in consultation with community groups, local and regional government and the private sector. However, a firm time frame for adoption of regulations (3 to 5 years would seem appropriate) should be stipulated in the process. 1.50. In the medium term, GOI will need to commit a significant level of resources to implementation of community development initiatives in forestry areas. An accumulation of funds via a mechanism similar to that currently used for the reforestation fund (or even a specific allocation from within that fund) would be one alternative; regular allocations from the general budget would be another. No calculation has been attempted in this study of the amount of funding this initiative would require. While it would be difficult to disburse large amounts initially, in advance of specifically designed programs and projects being available, 12 . it is nonetheless recommended here that a substantial commitment of revenue to this purpose be made. It _would be appropriate to think in terms of eventual allocations in the order of $50-$100 million per annum from revenue, fo! this purpose. To this would be added whatever contributions the private sector, international donor agencies and other source may be willing to make. Such a commitment would send an appropriate signal from Government that it is serious about participation - to the international community, and to national interest groups. This will in tum stimulate grater involvement by such groups in the task of developing realistic proposals and programs. In keeping with the emphasis in this report on implementation, a substantial allocation of funds will focus attention on investment possibilities, rather than primarily on further study of the problem. 1.51. For this to proceed effectively, it will be necessary to develop an effective mechanism for channeling such investments to affected communities: there are already many experiments and studies current (or completed) on community participation in forestry in Indonesia- some of which have developed successful approaches. What is lacking is adequate investment and institutional capability to follow these up with field scale activities. The best approach to rectifying this would be establishment of a foundation which would be empowered (and funded) to identify and negotiate with groups likely to be affected by forestry prior to initiation of field activities, and to support investments. These might include financial participation in forest operations or in follow-up management of regeneration (possibly including allocation of concessions to communities for this purpose), and in plantation schemes: all of which could be supported by the community development fund. In essence: it is necessary for Indonesia to break awaY, from the historical relationship which has developed between forest dwelling and adjacent communities, and government agencies; and also to deliver meaningful financial backing to development for such communities. The principle underlying this suggestion is a simple one: involving forest dwelling and adjacent communities is managing the forest resource - rather than encroaching upon it - will cost money. If Government wishes to pursue sustainability, then investment of substantial funds in participation must be regarded as a pre requisite, and the commitment should be made clearly. 1.52. Institutional change. The preceding paragraphs already imply considerable institutional change in Indonesia: a greater role for communities and possibly local governments in the management (and ownership) of the resource; a lessening of institutionalized support in government regulations for the existing processing sector, in favor of more market oriented outcomes; independent (private sector based) audit of forest operations; possible alteration in the mechanisms under which logs are sold. 1.53. Even more change than this will be required. The Government of Indonesia has recognized in its general development policy a need to decentralize decision to the field - to the level where consequences and impacts are fact. This is a particularly important measure where natural resource and land decisions are involved, and yet the Ministry of Forestry remains one of the most highly centralized of all Government departments. . 1.54. Not only is devolution to regional authority indicated, but so also is devolution to the private sector of tasks which are not directly related to government - i.e. the formulation of policy and regulations, and accountability for their observance. Indonesia already has a successful example of privatization of a public task, in the contracting out to a private consultancy group of the management of significant areas of the customs and excise function in Indonesia. One possibility in forestry example be would be use of the private sector for the independent audit discussed in para 1.41. above. There are other functions in forestry which could also be considered for this approach: inventory and related data gathering and management; aspects of research; large sections of what is currently done in field control of forest operations, including log management and marketing; and implementation of plantation policy. 13 Focus. Organization and Objectives of this Review 1.55. This review should be considered in the context of the broader concerns of the Bank 4 , and other donors, in relation to the use of forest land in Indonesia. In particular, it should be seen as a companion to the recent broad based Bank review of environmental issues in Indonesia, entitled Environment and Development: Challenges for the Future. That review deals with issues such as: land resources management; management of ecosystems and protected areas; and water resources - in addition to major pollution issues. The objective of this natural forest management report is to focus on that very significant part oflndonesia's natural forest area which is subject to forest operations and wood extraction. At present, a very large area - some 700 000 hectares - of forest in Indonesia is logged annually. To date, much of this logged over forest bas been subsequently converted to other uses (see Chapter m- much of it on the basis of official conversion programs. 1.56. To treat future logging in natural forest areas as part of sustainable forest management will require very different approaches, on the- part of both government and the private sector, than have applied in the past. Even if significant areas of forest in Indonesia can be set aside in large blocks for purposes of biodiversity conservation (and this is by no means certain), the very size of the logging program' suggests that considerable identification and preservation of specific biodiversity and other assets will still need to be done in the context of forest management. How the sustainable management question is approached in the near future in Indonesia therefore has strong implications for biodiversity and other conservation values. The capacity to manage such areas at a field level, and to integrate both environmental and social concerns into management, is crucial to the overall forest land outcome in Indonesia. There is no option, in Indonesia, to close down forest operations or even significantly curtail them: this is neither economically nor politically feasible. Further discussion of the natural and global economic aspects of sustainable forest management in Indonesia is given in Chapter III of this study. 1.57. A major determinant of outcomes for sustainability will be developments in trade in forest products, in this high export sector. It will be argued in this report that Indonesia must draw the right messages from historical and current international trade developments in forestry and forest products and, in this area, it is particularly important to ask the right questions: Is a lack of sustainability in tropical forestry attributable to exploitive and discriminatory trading practices on the part of major consumer nations, or does it relate more to domestic policies which equate overall gains in value added to improvements in efficiency and competitiveness of the forest products sector? How important is the 'green' factor in international trade: the development of market resistance to forest products not demonstrably produced from sustainably managed resources? What policy options and instruments are available to Indonesia to draw sustainability, efficiency and competitiveness together in the forestry sector? 1.58. This review approaches these questions according to the following analytical structure: • The existing status of the forest resource (Chapter m • Chapter III discusses the implementation of forest management in Indonesia and options for improvement. This subject includes analysis of the economics and environmental aspects of the plantation sector in Indonesia, because it is, on current practices, inseparable both locationally See lndones1a: Sustainable Development of Forests, Land and Water (World Bank 1990); Biodiversity Conservation in Indonesia (World Bank, 1992); and the Bank's environmental review Environment and Development: Challenl!es for the Future (World Bank 1993). The Bank is investing in forest and mangrove conservation activities under current forestry loans (Forest Institutions and ConservatiOn Projects I and II), and is preparing maJOr investments in forest conservation under Global Environment Fund financing in the Kerinc1 Seblat National Parks, and in a forthcommg watershed conservation prOJect. 14 and in a corporate sense from natural forest operations. It also includes the present status of forest dependent communities in Indonesia, because, in addition to the imponant objectives the Government of Indonesia has for these communities (as discussed in the preceding section), it is clear that no genuinely sustainable forest management is possible without their involvement. • The present and potential role of the forest processing industries in Indonesia. This subject opens with consideration of some imponant market and trade questions, and proceeds with a sub-sectoral analysis of the Indonesia forest products industry (Chapter IV). 1.59. These elements will lead to a series of observations on policies and institutional aspects of the sector in Indonesia: • The role of log prices in allocation of the resource is a crucial factor: drawing together the efficiency of usage of the forest resource and the processing sector, and the broader aspects of the sustainable management of the resource. This is discussed in Chapter V. • Chapter VI closes the report, by recapitulating the policy issues which arise from the foregoing chapters, analyzing the institutional implications of policy reforms for implementation of sustainability, and proposing some immediate measures which might be taken. 15 CHAPTER II FOREST RESOURCES Introduction 2.1. The basic set of data upon which a policy of sustainable forest management is implemented is the area, and condition, of the natural forest resource. In Indonesia, there is considerable uncertainty on this matter at present: the Government recognizes this, and is presently involved in an extensive national forest inventory program 1, which will provide improved estimates of forest area and type. 2.2. In the meantime, the best approach to gaining some insight into the resource is to review existing official estimates and then to examine some recent analyses of the existing zonation of forest areas, and of deforestation and illegal removals from the forest. In sum, this process indicates that, even if current official estimates of forested area are accurate now, the area available for commercial exploitation may be less than the figure given, and the rate of removal from that area may be well above the sustainable removal figure implied in Figure 1 above. On the other hand, recent estimates of deforestation in Indonesia are lower than earlier ones, and the deforestation which is occurring may be more controllable through official Government action than previously thought. Forest Area and Resource Availabilitv Projections 2.3. The Action Plan for Forestrv Sector Development in Indonesia (op cit pg.6) projects total forested land areas for Indonesia to 2030 AD as follows: Table 2.1: PROJECTED TOTAL FOREST LAND IN TilE OUTER ISLANDS (IN MILLION HECTARES} 1990 Regton Foreslry 1995 2000 2005 2010 2015 2020 2025 2030 Studies Sumatra 20.382 19,380 18,662 17,987 17,506 16,922 16,559 16,084 15,664 Nusa Tenggara 2.536 2.308 2,271 2,237 2,212 2,186 2,165 2,141 2,120 KalimanLBn 34,732 33,129 31,866 30,661 29.682 28,676 27,867 26,912 26,114 Su!awes1 10,330 9,978 9,7076 9,448 9,267 9,069 8,920 8,716 8,550 Malulcu 6,029 5,687 5,415 5.159 4,951 4,740 4,568 4,370 4,203 Irian Jaya 33,649 32,539 31,642 3o,m 30,055 29,306 28,710 27,990 27,392 Outer Islands 107,478 103,021 99,562 96,264 93,672 90,969 88,830 86,212 84,044 Source: Table 2, Action Plan for Forestrv Sector Development in Indonesia, Ministry of Forestry, 1991. 2.4. Projections of supply from natural and plantation forests, are discussed at some length in chapter 5 of the Indonesia Tropical Forestrv Action Programme2 , produced for the TFAP Roundtable ill conference held in Yogyakarta in February 1992. Volume available from natural forest utilization shown in those projections decline from 29.8 million cum p.a. in 1995, to 21.5 million cum p.a. by 2030. As of 1990 1 The National Forest Inventory Project, fmanced in cooperation with the World Bank under the Fiist Forest Institutions and Conservation ProJect loan (FICP I). :: Ministry of Forestry, 1992, Indones1a Tropical Forestrv Action Plan, Country Brief. 16 approximately 11 million ba of production forest bad been logged, of which about 5 million ba iippears to have been heavily logged. J\bout 30 million hectares of production forest remains unlogged. Factors Influencing Resource Estimates 2.5. Uncertainties as to the extent and nature of the natural forest resource arise, firstly, from data difficulties implicit in initial growing stock and yield estimates, and secondly, from imprecise information on the dynamics of change in the status of the resource from that point on. The first category includes issues related to inventory, and also the matter of zoning: the extent to which use categories of forest areas are correctly identified. This matter is examined below. In the second category, deforestation losses, and the dimensions of illegal removals from forested areas are two important factors in the dynamics of forest cover, and these are briefly reviewed, following observations on zoning. 2.6. Inventory and forest land use zoning. A major inventory exercise is currently under implementation in Indonesia, in a joint GOI-FAO-World Bank project being supported under the Bank- GOI Second Forestry Institutions and Conservation Project. Preliminary results can be expected from this by early 1994, and more comprehensive results by 1995-96. In the meantime, estimates of standing volume and increment will continue to be based on crude, generalized growth and yield figures. The possibility of major errors and misconceptions about the true volume available is large, under these circumstances, although hopefully not as large in general as illustrated in the case described in Box 2.1. Box 2.1: REVISING ESTIMATES OF CONCESSION OUTPUT A recent environmental audit of a forest concession in East Kalimantan carried out by the Environmental Impact Managemenr Agency (BAPEDAL) revealed that the company operating the area bas extracted an average of 140 000 m3 p.a. from the site- and the annual harvest has declined in recent years. Original estimates of the annual allowable cut from this concession ranged from 382 000- 612 000 m3 p.a. It is in fact not uncommon for actual output to differ from original standing volume est1mates, but it is important that such differences be minimized by adequate concession level inventory work, and that discrepancies are factored mto national inventory estimates as they arise. 2. 7. Some revision of available volume arises from re-zoning of forest land. Under the Basic Law of 1967, the Ministry of Forestry has jurisdiction over all land designated for forestry use. At present, about 70% of all land in Indonesia is designated as forest area. This distribution resulted from a Consensus Land Use Plan (Tata Guna Hutan Kesepakatan - TGHK), which was signed off by 8 Ministries and Provincial Governors in 1984/85. The process of formulation was coordinated by regional planning boards (BAPPEDAS), and the Ministry of Forestry was involved via its regional representatives (Kanwil Kehutanan). 2.8. The TGHK maps and zoning are the basis for the current Ministry of Forestry categorization of forest land: Category '000 ha Protection forest 30.319 Park & Conservation forest 18.752 Limited Production forest 30.526 Production forest 33.867 Conversion forest 30.517 143.981 17 2.9. The distinction between protection, limited production and production forest in based on an erosion index, which is calculated from soil type, slope and rainfall figures. In terms of use, constraint on operations in protection and limited production forest is limited to the timber harvesting system: criteria on road location and construction - potentially the most damaging aspect of operations - are not specified. The division between production and conversion forest is made by and large on a consensus basis, rather than according to firm criteria. The overall total of 144 m ha denotes area officially designated as forest: since virtually all of this area of officially designated forest land is on the outer islands (i.e. excluding Java), the figure may be compared directly to the total estimate of actually forested area given in Table 2.1. (107.5 m ha). 2.10. A number of problems have been identified with the TGHK system: Categories of forest area were identified on very large scale maps, and resulting divisions are inadequate for operational level planning. Occasionally, category boundaries do not match on adjacent map sheets. Inadequate information existed at the time of the classification to objectively decide upon categories, in many cases. No identification is made of land currently being used by rural populations for subsistence and cash farming. This fails to recognize often long-standing residency by some groups. Although allocations of land to HTI Schemes and other uses are supposed to be based on existing vegetative cover, and to make exclusions for environmental reasons, neither characteristic is recorded on the TGHK maps. 2.11. In the case of concession operations in particular, there are examples of concession areas overlapping each other when located on a single map. Subsequent revisions (see paras 2.12 to 2.14 below) to land use maps indicate that many concessions include substantial areas of non-forest land, and also of land which, for reasons of slope, fragility or other criteria should not be subject to forest operations. 2.12. An attempt has been made to identify the scale of this problem, utilizing theRe PPProT data. This is the information contained in the Regional Physical Planning Program for Transmigration, prepared in the Ministry of Transmigration over the period 1984-1989, based on photography and other data spanning a period 1972-1986; updated with LANDSAT imagery in the case of earlier material. TheRe PPProT study identified 19 separate forest types for the Outer Islands, and using a base year of 1982, determined a forest cover estimate of 120 million hectares for that year. Dick3 reports results from a reclassification within the TGHK designations, using Re PPProT data and a subsequent revision ofTGHK definitions, to more accurately reflect present land uses and condition, better ecological consistency between zones, and improved information on soils, topography and rainfall. Results of these two approaches to reclassification of forest areas are given in Table 2.2 below. 2.13. As can be seen from comparison ofTGHK and RePPRroT, the most significant result from this exercise is that the limited production and production forest categories are reduced by 45%; increases are recorded in protection forest and reserves. Based on Ministry of Forestry criteria, under the new classification, a significant proportion of land currently under concession is too susceptible to erosion to be logged. The reclassification of the RePPProT data reduces production forest considerably: the result can also 3 I?ick, J 1991, Forest Land Use. Forest Zoning and Deforestation in Indonesia, Background paper prepared for State Ministry for Population and Envtronment (KLH), and the Environmental Impact Management Agency (BAPEDAL), for UN Conference on Environment and Development. 18 Table 2.2: RECLASSIFICATION OF FOREST FUNCTION AREAS Area in 100 Ha = Km2 Agreed Reclassifi- Sumatra Kalimantan Sulawesi Nusa Tenggara Maluku Irian Jaya TOTAL Forest tion Funct1on Approach .KriJl % Kml % Kml % Kml % Kml % Km2 % Km2 % TGHICI Nature Adjusted 11,111 9 36,386 7 14,126 8 3,199 1,531 6 73,700 18 173,659 10 Reserve (PPAIHSA) RePPProTl 13,781 9 63,128 12 27,625 15 23,713 15 na 6 86,300 21 211,550 14 reclassified TGHK 1 Protection Adjusted 64,121 14 65,471 12 43,202 24 16,372 20 13,309 17 105,000 25 307,475 17 Forest (HLIHB) RePPProTl 115,202 21 88,933 17 100,295 51 88,633 56 na 156,000 38 519,063 31 reclassified TGHK 1 Limited Adjusted 66,579 14 118,266 22 45,877 25 7,913 JO 16,426 21 46,300 11 301,358 17 ProductiOn Forest RePPProTl 17,529 77,600 11 2,073 1 8,283 5 na 20,100 5 125,858 7 (WPT) reclassified TGHK 1 Normal Adjusted 69,319 14 132,246 25 14,222 8 5,527 7 8,624 11 80,300 19 310,238 18 Production Forest RePPProTl 53.755 11 88,992 17 1,535 1 1,691 3 na 60,000 11 208,776 12 (ADBIHP) reclassified TGHK 1 Conversion Adjusted 86,760 18 115,316 22 16,241 8 17,144 21 31,638 44 97,600 24 367,699 21 Forest (HPKIHK) RePPProTl 233,290 19 206,291 38 51,631 29 32,682 21 na 83,000 20 609,897 31 reclassified TGHK 1 State Free Adjusted 5,617 1 5,617 1 Forest (HNB) RePPProTl 1,511 <1 1,511 <1 reclassified TGHK 1 Un- Adjusted 141,312 30 68,591 12 52,177 27 30,315 38 504 1 11,900 3 301,799 17 classified (UNLINPD) RePPPro"P 9,791 2 11,172 2 0 27 800 21 na 9,100 2 31,163 2 reclassified TOTAL TGHK Adjusted 171,819 100 536,276 100 186,145 100 80,770 100 78,035 100 111,800 100 1,770,845 100 TOTAL RePPProT 171,862 100 536,219 100 186,159 100 158,805 100 na 111,800 100 1,770.815 100 1 Tata Guna Hutan Kesepakatan 2 RePProT reclassification of forest function areas Source: Tables 4 and 5, J.Dick forest Land Use, Forest ZQnation and Qeforestation in Indonesia Background Paper to UN conference on Environment and Development, prepared for State Ministry for Population and Environment (KUi); and the Environmental Impact Management Agency (BAPEDAL}, 1991. 19 be compared to official estimates of production forest area as given in the Indonesia Tropical Forestry Action Program document (see Table 2.3). Table 2.3: ESTIMATED AREA OF EFFECTIVE NATURAL FOREST COVER IN INDONESIA BY REGIONS, 1990 Mixed Hardwood Tidal forest Forest Forest as with Mgt. within Other Total Percentage Region Production Other Forest Potential nature Forest Forest of land area Forest with Mgt. Potential - reserves Sumatra Kalimantan 8.37 16.74 3.60 5.97 . 0.39 0.89 3.47 3.04 4.55 8.09 20.38 34.73 43 63 Sulawesi 3.62 1.33 0.14 1.20 4.04 10.33 52 Maluku 2.06 1.96 0.20 0.41 1.40 6.03 70 Irian Jaya 9.68 6.09 0.53 6.17 11.18 33.65 82 Nusa Tenggara 0.17 0.35 0.91 0.13 1.70 2.36 . 29 Outer Islands 40.64 19.30 2.16 14.42 30.96 107.48 60 Bali - - - 0.12 0.01 0.13 23 Jawa 0.18 - - 0.12 0.76 0.76 7 TOTAL 40.82 19.30 2.16 14.56 31.73 108.57 56 Source: Table 3.1 Indonesian Tropical Forestry Action Plan, (op cit, see pg.8). 2.14. If nothing else, the disparities evident indicate the highly uncertain nature of existing classifications. There is awareness within the Ministry of Forestry and other agencies that the quality of information used to allocate concession areas, HTI sites, and to manage such areas, is poor. Some improvement can be expected upon completion of the national forest inventory, due in 1996, but alone, this will not provide sufficient concession level information. It is clear that considerable improvement at least in the location of existing concessions, and zoning of the forest according to the existing categories, could be carried out utilizing RePPProT and some subsequent imagery data, and also the extensive aerial photography which has been prepared by APm - the concessionaires association - which now covers some 60% of concession areas. 2.15. An opportunity may exist to implement zoning changes under the new KPHP system, under consideration in the Ministry of Forestry at the present time. The essential idea of this system is to regroup production forest areas into Management Units, administered at the Provincial level. New boundaries would be drawn for each unit, based on the latest information, and consensus between interest groups. Although some large single existing concessions might be formed into a KPHP without addition of more areas, more often groups of existing concession areas will be merged into KPHP. 2.16. Obviously, implementation of this system will require some difficult decision-making in two respects: Firstly, the new boundaries to be agreed upon and introduced will, in many (perhaps most) cases, reduce effective production areas for concessionaires in a given area. Whether the remaining resource should be auctioned; or partitioned amongst concessionaires on a pro rata basis (calculated from remaining resources in old concession areas); or allocated in various other ways; remains a matter f')r consultation and decision. The role of provincial and local authorities, will also need to be given consideration. The central argument which will, one way or another, eventually enforce some form of reallocation and reclassification of the forest resource, has been summarized by Dr. Alistair Fraser: 20 "Now that the whole forest area is committed, and has also declined in extent due to various forms of forest clearance, while industrial demand probably exceeds the remaining supply, there could now be competition between users or user groups to secure access to continued supplies". Alistair Fraser (ODA - Indonesia Tropical Forest Management Project Coordinator), The Role of the Private Sector in Management of KPHPs (unpublished discussion paper). 2.17. Second, the decision-making process will in many instances be further complicated by the existence of community counter-claims over some forested areas (see paras 3.110 to 3.127 for an overview of the community issue in forestry in Indonesia). At present, the proportion of forest land occupied and/or claimed by local communities in Indonesia cannot be determined with any accuracy: recent estimates range from 10% to 60% of total forest area. Some recent exercises in mapping of community-claimed or managed areas have demonstrated that it is possible to accurately determine boundaries of community areas (see Box 2.2). Box 2.2: MAPPING A COMMUNITY MANAGED TERRITORY IN INDONESIA'S FORESTS In 1992, the inhabitants of a single village in East Kalimantan, (Long Uli), in collaboration with the Forestry Depanment (Directorate General of Forestry Production and Directorate General of Natural Forest Protection and Preservation), the East West Centre (Environment Program), WALHI {Institute of Dyakology Research&. Development Divis1on), World Wildlife Fund (Kayang Mentarang Project), mapped the areal c.xtcnt of lands under village control and management and the Interrelationships betWeen village territorial boundaries and forest department maps. The project is highly significant because it demonstrates that historic village management areas can be mapped with precision and that the overlapping areas between village managed territories and MOF designated forest zones including producuon and protected areas, can be specified. It showed that a collaborative, inter-institutional methodology, involving villagers, non-governmental organizations, governmental institutions and international environmental institutes can be designed and implemented in the service of sustamable forest management and in the rational clarification of territorial property rights and boundary dispute resolution. When forest land use (TGHK) maps were superimposed over the mapped village lands, it was revealed that the village is divided in the middle by two land users, a forest concession and a nature reserve. Together, these two external land users cover a total of Sl percent of Long Uli land. 31.1 percent of Long Uli land (5,661 ha) overlapped with the Kayang Mentarang Nature Reserve and 19.6 percent (3,576 ha) of Long Uli land is covered by a forest concession. When the forest concession and nature reserve overlaps are combined, they cover all of the village cultivation land. In addition, conversion forest covers 36.2 percent of Long Uli land and Limited Production Forest cover 13.7 percent of village land. A number of options have been proposed in this particular case: one would involve altering the status of the nature reserve to allow villagers access for traditional purposes to part of it. Another would involve relocation of concession boundaries to exclude the area used by villagers for fuel and construction materials extraction. A more integrative approach would be to renegotiate land use management for the whole area, involving all parues - the community, the Mirustry of Forestry, and the concessionaire - with the mtention of reaching a consensus su1table to all. The technical challenges in producing maps of the type described above are lessemng as more sophisticated data imagery technology becomes available. However, there would be little point in introducing such technology, until firm decisions on the legal and institutional changes needed are made. These are discdssed in paras 3.110 to 3.127, and 6.13 to 6.18. Source: This example is drawn from informauon provided in a working paper for this review entitled Indigenous Forest Dwelhng Commumties in Indonesia's Outer Islands, by Charles Zerner (1993). 2.18. Deforestation. Deforestation can, according to the perceptions of the user of the term, mean anything from total removal of tree cover, to relatively small alterations in the ecological composition of a forested area. Most available analyses of deforestation in Indonesia clearly mean something closer to the former, although few actually specify a definition. 21 2.19. of The two most commonly cited estimates deforestation in Indonesia are by FAO (1991)- which gives a figure of 1.3 million hectares per annum- and the World Bank (1990}, which estimates a rate of 900 000 ha per annum. These sources are cited in Table 2.4 below. These estimates place Indonesia second only to Brazil, in annual areas deforested. 2.20. Table 2.4 summarizes these and some other recent estimates of deforestation in Indonesia. Table 2.4: ESTIMATES OF DEFORESTATION IN INDONESIA AGENT Source of Trans Estate ·swamp Swakarsa Trad'd Forest Fires TOTAL Estimate Dev't Crops Dev't Tnmsmig Ag. Harvest WB 1990~ 250 . 500 80 70 900 FAO 1991~ 300 274 85 461 80 113 1315 TAG 1991~ 65 11.4 30.4 156.5 NE NE 262.9 MoFr 1992~ 300 160 300 77 478 1315 !1 Dick 1991~ 78.4 11.4 30.4 178.5 135.5 120 70 623 MoFr 1993!' 840 !1 Fire damage averaged excluding major Kalimantan fire loss. Sources: 11 World Bank Indonesia: Sustainable Development of F~ts. Land and Water, 1990 Z.l Food and Agriculture Organization (F AO) Situation and Outlook of the Forestry Sector in Indonesia, 1990. 2_/ Transmigrauon Advisory Group (TAG), Forest Clearance Study. Ministry of Transmigration, 1991 ~I Ministry of Forestry (MoFr) Indonesia Tropical Fo~ Action Promm, 1992. 2_/ Dick, J. Forest Land Use. Forest Use-Zonation. and Deforestation in Indonesia, Background paper for UN conference on Environment and Development, prepared for KLH and BAPEDAL, GOI, 1991. §.1 Ministry of Forestry Preliminarv Studv on the Rate of Forest Cover loss in lndonesta National Forest Inventory Project, INTAG and FAO, 1993. 2.21. Dick (op cit, on pg.l7) argues that both the 1990 World Bank and 1991 FAO estimates are too high, because they: assume official tenure change is equivalent to actual conversion; assume that all causes or agents of deforestation are additive, whereas in fact smallholders, for example, will usually occupy lands alreadv disturbed (by logging, fire or etc.); and appear to assume that all area presently under shifting cultivation bas been deforested in the last 10 or IS years, whereas in fact shifting cultivators occupy much land which bas never been forested (or bas been cleared for many years). 2.22. Dick suggests that the Transmigration Advisory Group figures based on the RePPProT data with some upward adjustment to correct for an increasing rate of clearing towards the end of the observation period, should be accepted for regular transmigration, estate crop and swampland development clearing. Dick derives unofficial transmigration figures from Ministry of Transmigration figures, and adjusts FAO figures for losses to harvesting upwards, to account for some observed forest disturbance in montane areas not accounted for. 22 2.23. Overall, Dick's analysis of deforestation seems reasonable although, as he points out, the data available are so poor that the reliability of any current estimate is low. Preliminary results from the Ministry of Forestry/FAO National Forest Inventory Project, being undertaken under the World Bank Second Forest InstitutiOns and Conservation project, indicate an annual forest loss figure for Indonesia of 840 000 hectares (but there is a wide confidence margin for this estimate at this stage). 2.24. One of the most interesting implications from Dick's analysis is that programs either sponsored or encouraged by Government account for 67% of all deforestation. Even the 21% attributed to traditional agriculture may be an overestimate, given the likelihood that much of this is occurring on secondary forest which regenerates as part of a shifting cultivation cycle. 2.25. While this interpretation may challenge the conventional wisdom, which holds that shifting agriculture is the main (or a main) agent of deforestation, in one sense it would be an encouraging finding. It is fairly widely accepted that a certain amount of forest land in Indonesia - especially forest of less quality and biodiversity value- should be converted to more productive uses. Dick's estimates would confirm that most deforestation occurring is potentially part of this process: if inappropriate decisions as to ~ should be cleared are presently occurring, it is at least within the reach of Government agencies to rectify such mistakes via administrative fiat. One major case in point, which has been raised previously by the Bank", is the system of land regulations in Indonesia, which cause public lands - including forest lands-to be sold at prices far below market rates. This practice in effect subsidizes the conversion of forests to other uses, in addition to causing inefficient land use throughout and reducing government revenues to well below potential. 2.26. It is important to recognize that the projections of forest output given in Figure 1 are predicated upon a fairly low rate of deforestation in the future: around 500 000 ha per annum to year 2030. If the reasoning in para 2.25 above is valid, then this is possible, providing Government sanctioned clearance of forest areas stays within limits defined, and forest dwelling or adjacent communities can be more effectively engaged in the process of long term management of the resources. 2.27. Illegal removals. Quantification of illegal removals, virtually by definition, is difficult. In the case of Indonesia, there is added.complication in that the level of legal, or officially recorded removals is in some doubt. In the Indonesia Tropical Forestrv Action Plan Executive Summary (op cit, on pg. 8) it is stated that log production in 1988 reached 32 million cum, whereas Forestry Statistics of Indonesia gives figures of 27.6m, 26.4m and 21.9m cum for 1987/88, 1988/89 and 1989/90 respectively. As noted in ITFAP, the consensus allowable cut figure from the Indonesian resource at tbe present time seems to be 31.4m cum pa, declining to 25m cum pa by year 2000. 2.28. It is evident that most logs taken by local people for basic, local use, will not be recorded and might in some senses be regarded as illegal removals. No estimate can be attempted here as to what the figure for sucb removals might be. Of more direct interest to GOI will. be discrepancies between official removal figures and volumes apparently consumed in processing operations; volume for which fees should have been paid. It is also difficult to obtain a consistent data set for these figures. Table 2.5 summarizes some recent figures on log production and processed output in Indonesia. ]2.29. Log conversion factor estimates for plywood manufacture vary, but in Indonesia seem to range between 50% and 55%. A rate of 55% will be assumed here. Sawn timber conversion factor estimates are lower: as suggested in para 4.54, a study by Atlanta Consultantss estimated a figure of 43% for 1988: a rate of 45% is assumed here. Assuming (conservatively) that current production of sawn timber _is on the order • Indonesta: Land Resources Mana2ement and Planmng, World Bank, 1991. 5 Atlanta Consultants/lmproma (1987) Wood Processing Industrv Sector Studv (7 volumes). 23 of 8 m cum, and plywood 10m cum, and applying the conversion factors, leads to a total log consumption estimate of about 36 million cum, in these forms of processing in Indonesia. If anything, this will be an underestimate of total log consumption in Indonesia: as noted earlier, use of logs in the informal sector will not be included at all in these figures. Moreover, . production figures from registered mills may be understated, for obvious reasons, and some mill production may not be included at all in these figures. It is by no means unlikely that total log removals in Indonesia exceed 40 million cum per annum. Table 2.5: RECENT ESTIMATES OF LOG, SAWN AND PLYWOOD PRODUCTION (millions CUM) ITEM Source of Estimate 1992 1991 1990 1989 1988 1987 Log Removals ITFAP (1992) . 32 Ministry Forestry /~ 21.9 26.4 27.6 FAO Forest Products 27.5 28.5 26.9 Yearbook Sawn Production Ministry Industry /~ 10.48 FAO Forest Products 9.15 10.49 10.29 Yearbook Plywood APKINDO /~ 9.06 Production F AO Forest Products 9.25 8.78 7.7 Yearbook /~ Data supplied to Bank Review Mission. 2.30. Logged over areas. Although no formal estimates of the area of Indonesia's forests covered by logging operations each year are available, it can be inferred from volumes being removed that something in the order of 700 000 ba per annum of forest area is covered by logging. This is similar to recent estimates of deforestation. This does not imply that logged over areas are immediately subjected to encroachment and deforestation in Indonesia. It can be argued, however, that most areas which are deforested will have been logged previously. Taking these observations together, they do imply that most areas of forest in Indonesia which have been logged over have probably been deforested fairly soon afterwards: before regeneration has matured. 2.31. If this is so, then silvicultural and other management practices applied to regenerating areas will have had little opportunity to take effect so far in Indonesia. However, this situation should not persist in Indonesia: if sustainability objectives are to be attained, then most forest presently in existence will have to be retained as forest. This means that effective management of regeneration, restriction of deforestation to only low value forest areas, and effective involvement of local populations in sustainable management will all become priority tasks from now on. 25 CHAPTER m FOREST MANAGEMENT Introduction: Analyzing Options for Natural Forest Management 3.1. Controversy surrounds the management and use of forested land, because it is not possible to quantify the range of environmental, economic costs and benefits that apply under the various options for use. Nor, in many cases, is there agreement as to how the benefits which arise should be apportioned amongst interest groups in society. 3.2. Even when it is possible to envision reasonable consensus on areas of natural forest to be preserved for biodiversity and related purposes, the larger question of what should be done with remaining forest area remains unanswered. Answers will emerge, as better information on sites of most interest are identified, soil types and slope categories which preclude intensive use are demarcated, and the status and aspirations of communities living in or near forest areas are studied. It is likely that, as better information emerges, and as Indonesia's technical capabilities to manage and utilize forested areas more effectively grow, forest categories will alter size and location (see discussion in paras 2.12 to 2.14). However, it is unlikely that quantitative ana!ysis will ever take a larger role in decision making in this area, than qualitative judgement. 3.3. In Indonesia, as discussed in Chapter I, there is broad acceptance of the notion that most existing natural forest cover should remain as forest, and also that an appreciable part of this permanent forest estate must be used for commercial production. Preservation of the whole resource without commercial exploitation is not regarded as an acceptable option, and some analysis introduced in this chapter will bear out this view. Nor is it likely that transfers from the global community in pursuit of preservation have potential to alter this outlook significantly in Indonesia: the losses of forest production implied (see Chapter V for an estimate of what Government revenues alone might amount to) would simply be too large. More leverage of such compensatory funding might apply under debt relief arrangements, as have occasionally been tried in pursuit of conservation of forests. Even so, it seems unlikely that Indonesian external debt could be purchased at a sufficiently low price to allow such a measure to purchase significant preservation. As will be demonstrated in some calculations in this chapter, the economics of sustainable management of Indonesia's natural forests are reasonably attractive, and sustainability generates considerable environmental benefits: it could be made more attractive by international transfers, and in such a case -typified by the carbon offset programs now being pursued elsewhere by North America power companies - the leverage of limited funding could be extended considerably further. 3.4. It is important, to recognize the limitations on standard static economic analytical techniques in this area. As is well known to natural resource economists, natural forest management which involves very long rotation periods will, because of discounting, rarely compare favorably to short rotation crops, on an "average" hectare basis, but this may have more to do with the assumptions implicit in defining the average, than with reality. The result may reveal little about how much of a given forested area should be converted for other use, (because too many uncertainties exist to allow such a result to be generalized to any significant extent), or gn be converted, given reasonable limits on the investment capital required: it is clear that, with some 100 million ha of forest area remaining in Indonesia, the real choice for most of it will be continued management under forestry cover, or largely uncontrolled conversion to shifting agriculture. Relative prices change, both in response to external factors and, if large output changes are generated within the project of interest, internal factors as well; the costs and benefits of environmental factors and non-monetary services are usually not known with any precision, and are also likely to be non-linear. This will especially be the case for biodiversity: once a sufficient area of forest is reserved to protect a given species or group of species, than the margin value of additional reser.vatlons for the same purpose is very smaU. Further complication is added by the fact that much of the biodiversity conservation initiative is based on option value: preserving hitherto unknown species, or species of hitherto unknown importance. It is clearly impossible, under such 26 circumstances, to assign specific monetary values to the biodiversity assets of given forest areas. Instead, this analysis will treat biodiversity as a residual: it will show that what biodiversity values would need to be attributed to forest areas, to justify foregoing the benefits of utilization from them. The question of whether such values will be attributed and, if so, who will pay for them, must remain a metter for political and ethical judgement. 3.5. Economic analysis- particularly when extended to incorporate as many environmental and non- monetary factors as possible - can be of more assistance for deciding upon second-order questions: if natural forest management is to be practiced on the permanent forest estate, what options within this form are best? If plantation is to be done over a given area, what sort of plantation is best? This chapter of the review will therefore open with an analysis of some of these options, from an economic perspective. 3.6. In forestry - particularly natural forest management - the technical possibilities are frequently well beyond current practice, and this has strong environmental as well as economic implications. The Ministry of Forestry is strongly of the view that better utilization in the forest, and more efficient use of the resource in processing, are both possible, and vital to the future of the sector (this view is made clear in the Ministry of Forestry Action Plan (1991)). It will be suggested in this chapter that considerable efficiency gains are possible on the basis of known, implementable technology. 3. 7. In the case of plantation forestry, it can also be argued that a great deal can be achieved in a technical sense, given the sites available in Indonesia. In this chapter, however, most attention is given to the policy issues involved in plantation in Indonesia. Large scale plantation in Indonesia should be, and is, of primary concern to the private sector (including, however, local communities in this instance). The argument made in this review is that the incentives created for plantation by the existing policy arrangements are sub-optimal. In particular, plantations to support the large and fast growing pulp and paper sector of Indonesia may not require the level of subsidies presently being paid to large scale private investors, and may compromise potentially regenerable natural forest areas to a greater extent than need be the case, under different policy prescriptions. 3.8. A fundamental issue which underlies the achievement of natural forest and plantation goals in Indonesia, is the role and right of communities living in, or near forests - especially those groups who are significantly affected by major forest developments. It will be suggested in this chapter that, on paper at least, such communities do have rights to participate in forest use; and that these rights have been strengthened under recent Indonesian legislation. The implications are that, in future, there will have to be improved communication ana understanding between communities, the Government and the private sector, when large forest operations are at issue, if the sustainability objectives are to be achieved in practice; and that existing government initiatives to improve community participation in forest management need improvement. Economic Analysis of Sustainable Management Alternatives 3.9. The objective here is to compare some alternatives for natural forest management from the viewpoints of: the private investor (which involves financial analysis using the conventional measure of forest value- timber returns); the nation as a whole (which will take into account non-timber forest products, and environmental externalities); and the global community (which will include valuation of the carbon sequestering capacity of forests, since this is the one global concern which can be valued economically on the basis of reasonably accessible data). Biodiversity can only be valued on an area specific, case by case basis, and even then, valuation of many aspects is difficult. There are, therefore, no biodiversity value estimates for Indonesia's forests as a whole. 3.10. The INFORMAN Model. The INFORMAN (!Ndonesia FORest MANagement) model was developed to explore the conditions under which s'ustainable management of Indonesia's forests would be economically justified. Initially it was planned to use growth and yield data from production forests in 27 Indonesia. However, such data were not available. Therefore, the biological parameters of the model are based on a growth and yield study of mixed Dipterocarp forest in Malaysia. 1 3 .11. This particular study was selected from among similar ones primarily because it incorporates a relatively long measurement period (fourteen years) on the performance of the forest following logging (in 1974), and plausible projections in sufficient detail over a longer period (60 years). 3.12. The model consists of a spreadsheet divided into three main parts which provide information on the forest management alternatives being subjected to comparative analysis: (a) Simulation of forest growth and yield data through a series of harvest/regrowth cycles. This part of the model generates quantitative estimates of wood, biomass and carbon at strategic points in the cycle. It also develops estimates of commercial timber volume harvested by species and size classes. (b) Valuation of timber and non-timber products/services of the forest at strategic points in the harvest - regrowth cycle. (c) Financial and economic analyses to determine net present value of forest land from financial (Private); social (National) and global (International) perspectives, to permit comparisons of forest management alternatives. 3.13. A short description of forest management alternatives analyzed using the INFORMAN model is given in the following paragraphs. Further details of assumptions upon which the model inputs are based are included in Annex 1. 3 .14. Forest Management Alternatives. The alternatives analyzed were based on the following forest management options: (a) Polvcyclic versus Monocyclic Harvesting Systems. The Indonesian Selective Cutting and Planting System (TPTI) is the standard natural forest management approach in Indonesia. It is based on polycyclic harvests at intervals of 35 years and is designed for management of mixed dipterocarp forests which have an even distribution of tree sizes. It assumes that following removal of all commercial trees down to a specified diameter limit (53 em dbh is assumed), the residual stand will contain an adequate stocking of sound, undamaged pole-sized trees (20 em dbh and larger) which will grow into economically harvestable timber within 35 years. At least 25 of these trees is considered as a minimum residual requirement. The most obvious alternative to the rolycyclic system is Monocyclic Harvesting, in which regeneration of subsequent crops comes from seedlings which must grow through a full rotation period (70 years) before logging. (b) Minimum Cutting Diameter Limit - Present - 53 em vs. Market - 38 em In the INFORMAN analysis, two monocyclic options are tested: in one, a minimum diameter limit of 53cm is used. In the second, a lower diameter limit is allowed (ie more volume can be removed in the initial logging) on the theory that smaller logs are merchantable, and there should be no need to retain them on the stand (except to the extent where shelter or shade trees are required for some period The growth and yield study, in draft form, was undertaken by Mr. Yong Teng Koon, an officer of the Malaysian Forestry Department, under the auspices of a fellowship granted by the ASEAN Institute of Forest Management. 28 to ensure regeneration of seedlings) under a system where seedlings are being relied upon for regeneration. (c) Current Practice versus Improved Forest Management. For each of the three harvesting cycle alternatives, two logging and post-logging stand treatment options are examined: current practice- minimal planning, little or no post-harvest treatment; and improved practice- which combines carefully planned and executed logging at no net cost - reducing damage on the stand by 30 percent - with post-harvest protection and tending (up to year 10) at modest cost. (d) Low Intensity. Helicopter Logging. An additional alternative analyzed is polycyclic harvesting at relatively short, 15 year intervals, removing small volumes of high value timber with minimal damage to the residual forest relative to conventional, ground-based logging. Results of INFORMAN Analvses 3.15. The results of analyzing the preceding forest management alternatives are discussed in the following paragraphs. The discussion of the results is divided into two parts - firstly, the sustained timber yield implications of the various forest management alternatives; and secondly, their relative financial and economic performance. 3 .16. Sustained yield forest management. The results of the INFORMAN analyses do not support the underlying basis of the TPTI system - that following initial logging, regrowth of the residual forest will sustain timber harvests at 35 year intervals. The analyses indicate following an initial harvest of 56 m3 per ha, subsequent polycyclic harvests decline to about one-quarter of this level - probably too low to support a commercial harvesting operation. This is due to the fact that a large number of pole sized trees destined for subsequent harvest are damaged or destroyed during logging. Yang's study showed that there is no net increase in volume per ha during the first 7 years following logging, as mortality of trees damaged or disturbed by logging continues to exceed regrowth. Improved forest management raises subsequent polycyclic harvests to about one-half of the original harvest. Short-interval, polycyclic helicopter logging provides (small volume) sustainable timber harvests at about two-thirds of the original volume, due to minimal damage to the residual forest. 3.17. A monocyclic harvest at 70 years based on current practice results in sustainable timber yields of between 50 and 60 m cum per ha. Improved logging and post-logging stand treatment increases sustainable yield to 70 m cum per ha. 3.18. Discussions with a number of people with field experience in Indonesia combined with personal observations of regenerating forests in the region tend to support the INFORMAN analyses results which suggest that typical logged-over forests will take longer than 35 years to provide sustainable harvests of commercial timber. Biological and operational impediments to achieving sustained timber yields under monocyclic harvesting regimes are discussed in Annex 2 which concludes that since the basic assumptions related to the residual stand after logging are often not fulfilled, a 35 year cutting cycle is not likely not to sustain adequate volumes of commercial timber. A longer cutting cycle is believed to give a more realistic estimate of the sustained yield oflndonesia's natural forests. Since the polycyclic system makes high demands on both loggers and the forestry agencies who monitoring and controlling their operations, because of the need to maintain an adequate stock of young trees in the forest during logging, (a matter of less importance in monocyclic systems), these results offer a prima facie case for reconsideration of the present TPTI system. 3.19. Financial and Economic Performance of Forest Management Alternatives. The results of financial and economic analysis of forest management alternatives provide answers to many of the basic questions facing Indonesia'~ forest resource managers. These are discussed in the following paragraphs. 29 3.20. Is Management of Forest for Timber Production Financially and Economically Justified? In Table 3.1, forest management alternatives are compared on the bases of: financial returns (line 1) - from timber revenues; social returns (line 2) - timber revenue less the value of diminished non-timber forest products (NTFP) yields and erosion protection services, attributable to logging; and global returns (line 3) - timber revenue less: NTFP, erosion protection and carbon storage values diminished by logging. 3.21. A!> illustrated in Table 3.1, all alternatives produce positive financial returns (NPVs Year 0-70) at 10 percent discount rate. However, there are significant environmental and NTFP values lost in logging, as shown by the differences between: Financial Returns (line 1); Social Returns (line 2) and Global Returns (line 3) which take these "external" costs into account. Table 3.1: COMPARATIVE NP:Vs (US$/Ha) OF NATURAL FOREST MANAGEMENT ALTERNATIVES FOR UNDISTURBED FOREST LAND (YEAR 0-70) Indonesian Log Prices - 10% Discount Rate Present Logging 8t. Forest Management Improved Logging 8t. Forest Management (1) (2) (3) (4) (5) (6) (7) Polycyc Monocyc Monocyc Polycyc Monocyc Monocyc Heli 35 yr 70yr 70 yr 35 yr 70 yr 70 yr 15 yr 53 em 53 em 38 em 53 em 53 em 38 c:m 53 an (1) 1914 1901 2598 2143 2115 2901 668 Fin NPV (2) 1380 1371 1879 175 I 1729 2296 62.5 Soc NPV (3) 950 946 1380 1442 1426 1911 568 Glob NPV 3 .22. The fact that NPV of undisturbed forests to be managed for timber production is positive in aU three cases, could be taken as an indication that selective logging is economically justifiable, even from a society point of view. Production forest management provides significant financial returns. Furthermore, timber revenues are sufficient to offset the (quantifiable) negative effects of timber harvesting on non-timber forest products and environmental services. This would confirm that complete preservation of the forest so as to retain only these values would be economic only if other, as-yet-unquantified values such as biodiversity, ecotourism, etc. were high enough to reduce NPVs to zero. 3.23. The differences between the Financial NPV and the Social NPV ($400 to $600 per ha) can be taken as an indication of the level of compensation which private sector timber companies owe resource owners (Indonesia) for non-timber values lost in logging. The differences between Social NPV and Global NPV ($300-$500 per ha) is the net value of carbon lost by managing the land for timber production rather than preserving it in a natural state. This can be taken as indication of transfer payments (based on current green-house gas mitigation technologies) which the international community, or other parties seeking to offset their carbon emissions, might be willing to pay to Indonesia for forest land maintained in an undisturbed, natural state. 3.24. The figures in line 3 of Table 3.1 can be taken as a measure of the biodiversity and other unquantified assets value loss that would need to be attributed to each hectare harvested, to justify complete preservation of such forests. Since biodiversity is essentially a gloilai value, this figure would stand as a measure of the transfers needed from the global economy to Indonesia, to compensate the resource owner for each hectare of forest withdrawn from logging. When multiplied by some substantial proportion of the half 30 million hectares or so subjected to logging each year in Indonesia, very large transfers would result - higher, certainly, than is likely to be forthcoming from any international source. This would be even more the case if higher standing timber fees - as are recommended in this report - are used as the basis for calculation of transfers. 3.25. Once Logged. Is Long-tenn Management of Residual Forest Justified ? To answer this question, INFORMAN was used to compute the NPV of timber and non-timber benefits which would accumulate on a logged-over forest during a 70 year period following Jogging. The effects of the initial timber harvest were excluded from the analysis in order to isolate subsequent financial and economic returns to regenerating forest under alternative forest management regimes and treatments. The results, which summarized in Table 3 .2, generally support the hypothesis that long-term management of logged-over forests is justified, although this conclusion varies considerably between alternatives. 3.26. Financial NPVs at 10% (line 1) are either negligible or negative. for all cases based on conventional, ground-based logging. The fact that NPV at 10% is near zero indicates an inflation free internal rate of return of 10%. Although this would meet the Bank's criterion for an acceptable investment, it is considerably lower than Indonesian entrepreneurs are accustomed to and therefore can be taken as confirmation that private timber companies have relatively little interest in long-term forest management of logged over forests, under present conditions. It is particularly interesting to note that improved logging, combined with modest investments in improved post-harvest stand tending, produce lower financial returns (columns 4,5,6) than present practice (columns 1,2,3), indicating that, the treatments are not financially justified. Hell-logging, with short harvest cycles producing small volumes of high value timber, results in higher NPVs than conventional ground-based logging systems. Table 3.2: COMPARATIVE NPVs (US$/Ha) OF NATURAL FOREST MANAGEMENT ALTERNATIVES FOR LOGGED-OVER FOREST LAND (UEAR 1- 70) Indonesian Log Prices - 10% Discount Rate Present Logging & Forest Management Improved Logging & Forest Management I I (I) I (2) I (3) I (4) I (5) I (6) I (7) I Polycyc35 Monocyc Monocyc Poly eye Monocyc Monocyc Heli yr 70 yr 70 yr 35 yr 70 yr 70yr 15 yr 53 em 53 em 38 em 53 em 53 em 38 em .53 em (1) IS 3 2 7 (20) (19) 144 Fin NPV (2) 590 584 413 713 692 494 1108 Soc NPV (3) 622 620 456 749 733 536 1136 Glob NPV 3.27. When viewed from the National or International viewpoint the outcome of the analysis is different. · The fact that the Social (line 2) and Global (line 3) economic returns are positive for all cases indicates that additional benefits accruing from carbon accumulation, non-timber forest products yields and recovering environmental services are sufficient to justify maintaining logged- over forests. 3.28. The fact that the NPV of the "improved" alternatives (columns 4,5,6) is higher than that of their "present practice" equivalents (columns 1,2,3) strengthen the argument for improved logging and forest. management, from the national and international viewpoint, since they have a significant mitigating effect on the negative impacts of logging. It can be concluded that improved Jogging and modest investments in post- harvest management are economically justified. The results of the preceding paragraphs also support the case 31 for managing forests for their combined timber and non-timber values. This subject is discussed in paras. 3.33 through 3.35. 3.29. Would Changes in Discount Rates2 Effect the Long-term Financial and Economic Performance of Natural Forest Management? The financial and economic analyses of Table 3.2 were recalculated substituting a 5 percent and 20 percent discount rates for the 10 percent discount rate. The 5 percent discount rate results in positive financial returns in all cases and favours improved forest management, as illustrated in Table 3.3. The social and global returns to managing logged-over forests are approximately double those at 10 percent discount rate used in Table 3.2. As shown in Table 3.4, the 20 percent discount rate lowers NPV's, resulting in a less favorable outcome for the improved management cases. Table 3.3: COMPARATIVE NPVs (US$/Ha) OF NATURAL FOREST MANAGEMENT ALTERNATIVES FOR LOGGED-OVER FOREST LAND (YEAR 1 - 70) Indonesi~n Log Prices - S % Discount Rate ! Present Logging & Forest Management Improved Logging & Forest Management Polycyc Monocyc Monocyc Polycyc Monocyc Monocyc Heli 35 yr 70 yr 70 yr 35 yr 70 yr 70 yr 15 yr 53 em 53 em 38 em 53 em 53 em 38 em 53 em FmNPV 90 68 62 144 48 71 388 Soc NPV 1227 1262 948 1551 1507 1155 2254 Glob NPV 1270 1325 1021 1599 1577 1226 2290 3.30. Table 3.4 shows the returns to managing logged over forest at a 20 percent annual discount rate. At this rate, the private sector would not have a strong interest in managing the forest in this way. Although 20 percent is probably an overestimate of the real (inflation and exchange rate adjusted) rate of return to investment a private investor might now expect in Indonesia, it is closer to what investors have become accustomed to in the recent past, and this suggests that, without some additional inducement, private sector investors probable would not exhibit much interest in this type of investment in Indonesia. On the other hand, 20 percent is well above a social discount rate for Indonesia, and on this basis, the economic attractiveness of investment in this form of management from the global and social points of view in Indonesia can be judged a robust result. 3.31. Would Higher Log Pricesl Enhance the Long-term Financial and Economic Performance of Natural Forest Management ? INFORMAN analyses from Table 3.2 were recalculated, substituting international log prices for Indonesian domestic log prices. As illustrated in Table 3.5, financial NPV's at 10 % discount rate increase in all cases although they still remain relatively small. International prices result in only modest increases in social and global NPV's which tend to strengthen the case for maintenance and improved management of logged-over forest. The positive effect of higher log prices on long-term financial 2 The use of "social" discount rates, in the range of 5%, for forestry projects has been advocated by many economists. Although the prime lending rate in Indonesia's {Rupiah) cap1tal markets is 20%, the Rupiah is subject to inflation and devaluation and therefore the real, (inflation free) rate is lower. In the region, Sabah_ and Sarawak sell their logs to Japan, Taiwan and South Korea, at prices of about double those in the Indonesian domestic markets. In conducting this analysis, the Indonesian price for large diameter dipteropcarp logs - $851m3 was increased to 200/m3. The price for small diameter, non- dipterocarp logs ($501m3) was increased to $100/m3, etc. 32 and economic performance of forest management is not as great as might be expected. This is due to the fact that the portion of large sized dipterocarp logs, which command premium prices in international markets, decreases in the second and subsequent harvests - the large, old gro~ trees having been removed in the initial harvest. The impact of higher log prices in future harvests is also diminished by discounting. Table 3.4: COMPARATIVE NPVs (US$/Ha)· OF NATURAL FOREST MANAGEMENT ALTERNATIVES FOR LOGGED-OVER FOREST LAND (YEAR 1- 70) Indonesian Log Prices - 20 % Discount Rate Present Logging & Forest Management Improved Logging & Forest Management Polyc:ye Monoc:ye Monoc:ye Poly eye Monoc:ye Monoeye Beli 35 yr 70yr 70 yr 35 yr 70 yr 70 yr 15 yr 53 em 53 em 38 em 53 em 53 em 38 em S3cm Fm NPV 1 0 0 (11) (12) (12} 32 Soc NPV 281 280 189 331 330 230 515 Glob NPV 299 299 211 351 350 251 535 Table 3.5: COMPARATIVE NPVs (US$/Ha) OF NATURAL FOREST MANAGEMENT ALTERNATIVES FOR LOGGED-OVER FOREST LAND (YEAR 1- 70) International Log Prices - 10% Discount Rate Present Loggmg & Forest Management Improved Logging & Forest Management Polyeyc:35 Monoeyc Monoc:ye Polyc:yc Monoc:ye Monoeyc Heli yr 70 yr 70 yr 35 yr 70 yr 70 yr 15 yr 53 em 53 em 38 em 53 em 53 em 38 em S3cm Fin NPV 61 10 10 100 (11) (9} 469 Soc NPV 635 591 420 806 701 504 1433 Glob NPV 667 628 463 841 742 546 1461 3.32. The results of the forgoing financial and economic analyses serve to show that leaving forest land in a regenerating condition, although it produces modest financial returns from timber production, produces significant economic returns from the national and globaLpoint of view. Improved logging and post- harvest stand treatJnent increase financial and economic returns. The impact on the economic return being more pronounced due to increases in potential non-timber forest products yields, environmental services and the rate at which carbon is sequestered on regenerating forests. These conclusions remain valid over a range of discount rates and log prices. 3.33. The results do not suggest, in themselves, that natural forest management is always necessarily the highest and best use of all presently forested land. The limitations to this form of analysis raised in para 3.4 should be recalled here. In national aggregate terms, they can be taken to show that leaving forest land in a regenerating condition is a viable low intensity investment for the very large areas of land involved. They also show, very clearly, that when comparing natural forest management to other land uses, combining timber and non-timber values and including the gains from improved logging and other technologies, are critical elements in the analysis (although these matters are usually !!Q! considered in practice when such decisions are made). The foregoing analysis serves to show that such decisions should be made with care, (removal 33 of a regenerating natural forest is essentially irreversible), and in full awareness that, in this area public and private valuation of alternatives diverge considerably. Multiple Use Forest Management 3.34. The results of the preceding section support the case for multiple use forest management (managing forests for the optimal combination of timber and non-timber values), since the results show the value of non-wood products and services is high. 3.35. On the later subject, Panayotou and Ashton4 state: "When managed at all, tropical forests are almost always managed for timber, and other values are rarely considered. However, seldom is economic justification presented for focusing exclusively on one forest use. The concept of multiple use forestry is based on the recognition that a variety of goods and services can be produced from the same land, either serially or simultaneously and that such management can greatly increase the net value of the forest. In fact, this approach can help ensure conditions for the sustainable production of timber. This does not imply that all possible forest uses should occur in the same place at the same time. Integrated forest management involves encouraging some uses while discouraging conflicting ones .... There is little doubt that as the values of non-timber goods and services of tropical forest become fully apparent, optimal management will require division of forest landscapes into blocks that will be managed to meet different objectives using a variety of silvicultural protocols." 3 .36. This concept of managing forest to optimized benefits from timber and non-timber products and . services is illustrated by an example in Annex 3. The example illustrates how integrated management of forests for timber and non-timber products and services results in 50 percent higher benefits (NPV@ 10%) than management exclusively for timber or NTFP and environmental services. The Concession System 3.37. Large scale timber harvesting began in Indonesia, in the late 1960s. Most of the early operations were joint ventures involving both domestic and foreign firms. From the start, cutting rights to forest areas were allocated to the private sector under the natural forest concession system, which apportions a specific area of forest to a concessionaire, for operation over the fixed period (currently 20 years in Indonesia) under an agreement drawn up with Government. 3 .38. Initially, the bulk of concessions were awarded to foreign companies, but these have now been replaced by locally owned entities. Most concessions are now owned by (or at least have strong corporate linkages to) wood processing companies (primarily plywood manufacturers): this is the result of deliberate policy decisions by Government, to bring most of the resource under operation by processors who will presumably have an interest in long term usage of the resource. This situation has also probably led to increased concentration in the sector: although around 580 concessions exist in Indonesia, more than 30% of the resource area is under effective control of 20 companies; and in fact it appears that five ot: six corporate groups dominate the sector. This situation suggests that, if major changes in forest resource policy are to be implemented in Indonesia, these groups will need to be recruited as major agents of such change. It seem unlikely that change will, in the Indonesian case, extend to replacement of the concession system in toto - with, for example, an auction system for sale of logs, or timber rights, or a contract logging system administered by Government but selling into private log markets. Panayoutou and Ashton 1993 Not bv Timber Alone in Economics and Ecology for Sustaining Troptcal Forests, Island Press, Washington, D.C. 34 3.39. As was argued in paras 1.32 to 1.36-above, a primary objective for Indonesia's forestry sector must be the encouragement of an efficient log market; it was suggested there that use of auctioning or other competitive bidding systems for new timber rights, or rights over concessions which have expired or been withdrawn, would imp_rove the operation of the log market. Such systems should only be considered, however, where there is prospect of a genuinely competitive outcome. In Indonesia at present, there is a high degree of concentration in the extractive sector, and strong vertical integration with the processing sector: a deliberate result of previous policy in awarding concessions. Considerable regional monopsony or oligopsony is therefore present, and in such cases measures to administratively adjust fees for standing timber toward those which would prevail at international parity log prices and competitive conditions, would be more effective in the short term in transforming the log market. 3.40. It has not been possible to obtain precise data on the status of concession leases in Indonesia, but it is known that many concessions are currently approaching the end of their current twenty year lease periods: a large part of the forest resource will be coming up for consideration of renewal of concession licenses over the next several years, and this will be both a burden, and an opportUnity, for both the private sector and GOI agencies responsible for forestry: It will be a burden in the sense that new concession agreements are time consuming and expensive for both concessionaires and forestry agencies to prepare; it will represent an opportunity in the sense that new information on the resource, and new policy objectives for its use, can be more easily incorporated into future agreements, than superimposed on current ones. 3.41. Logging operations are carried out under three basic mechanisms in Indonesia: Contract logging: the concessionaire provides equipment and routine spares, and a contractor engages labor, and provides some spares and repair facilities; Logging on a royalty basis: the concessionaire assigns the rights to a contractor, who provides all inputs. Owner operations: the concessionaire directly controls the logging operation, and employs labor (usually on a bonus incentive system). 3 .42. It is not possible to comment directly on the efficiency of these different systems in the field in Indonesia: no assessment has been made. In principle, however, it would seem preferable for a concessionaire to be directly responsible for his logging operations: in other countries where contract logging is prevalent, the situation frequently arises where competition for such contracts becomes so intense that the winning operator can be forced to operate on very narrow profit margins with little to spare for innovations, or improvement of standards: the result - particularly when a government is interested in introducing new operational procedures such as more careful logging - can be highly unsatisfactory. In general terms, the Ministry of Forestry prefers concessionaires to be in direct contrel of their logging operations. Potential Improvement of Natural Forest Wood Avail ability 3.43. The Ministry of Forestry is strongly of the view that better utilization in the forest, and more efficient and effective use of the resource in processing, are both essential to GOI's strategy for sustainable forest use in Indonesia (MoFr Action Plan (1991)). This view is home out by the resource data reviewed in Chapter ll: clearly, some downward revision of sustainable forest output is inevitable in Indonesia, unless improved utilization and regeneration are implemented. 3.44. At present, most estimates of future wood availability in Indonesia are based on an overall regeneration estimate of commercial volume of about 1 cum per hectare of production forest per annum. It is known that increment varies significantly across different sites, and the growth and yield data supporting this overall figure are by no means comprehensive. 35 3.45. These are matters for research and inventory !=Oncern, but they also serve to emphasize the importance of improving both the growth yield ofthe natural forests, and the ability of logging and processing operations to utilize standing volume more effectively. 3.46. The FAO forestry studi~ estimate that current logging operations leave unutilized in the forest volumes of 23 million cum p.a. (of which 8 million cum p.a. is estimated to be sawlog or plylog quality). Moreover, the report claims that damage to trees left standing in the selective logging operations amounts to a further 13 million cum p.a. Jaakko Poyry consultants, in a forthcoming study of forest products trade in South East Asia (see op cit on pg. 56), estimate that, with proper management and control of logging operations, and some relatively minor inputs from there on into post-logging silviculture, regeneration on natural forest areas might grow at 2.0 - 2.5 cum/balannum, as opposed to the 1.0 cum currently assumed. In the analysis of management alternatives shown in paras 3.13 to 3.33 of this review, it was suggested that improved logging obtainable at virtually no additional cost could alone raise the level of regeneration after logging by around 30% in Indonesia. 3.47. The conclusion is that substantial wood availability increases would be possible from the natural forests in Indonesia, through application of known technologies for improvement of logging, and realistic improvement in utilization of stacc!ing volumes. Given the doubts about the current condition of the resource raised in chapter n, and the continuing dependence of Indonesia on forestry production, the payoff to investment in improved management and utilization will be high. 3.48. Two mechanisms by which such improvements might be pursued -- raising the value of standing timber (the economic rent argument); and altering basic silviculture for regenerating stands -are controversial in Indonesia and are taken up in chapter V, and paras 3.60 to 3.73 respectively, below. The third mechanism, improving operations through better monitoring and enforcement of existing prescriptions, is less contentious in principle, but raises many difficult questions in implementation: Improving Management of Forest Operations 3.49. The Ministry of Forestry bas extensive research, development and pilot programs on all aspects of forest management in progress, both in its own right, and jointly with virtually all international development assistance agencies which have any involvement with the forestry sector. It would require a major report simply to summarize objectives and findings from these projects, and this cannot be attempted here. 3.50. Instead, this review will attempt to: present an overview of what the current major issues and problems in natural forest management in Indonesia are; identify whether the solutions are technical, policy based or institutional in nature; and present some options which might be applied. 3.51. Before entering upon this exercise, in the interests of balance and perspective it should be made clear that considerable improvements have been and are being made in the administration and management of field forestry operations in Indonesia. In the area of enforcement, in recent years the Ministry of Forestry has increased the costs of non-compliance with concession obligations significantly. The present procedure is that, if breaches of conditions are identified, a concessionaire is given a warning, which is repeated once. If regligence continues, the allowable cut for the concession is reduced by 40%. If this does not remedy the situation, the concession license is canceled. According to the Ministry, up to June 1992, $20.5 million in fines bad been imposed (although not all seem to have been collected), and 29 concessionaire licenses had been revoked. Although, as will be argued in this review, the means and the motivation to implement enforcement procedures are more limited than they should be, the fact remains the penalties are there, and 5 Food and Agnculture Orgaruzation, 1988-91, (various volumes) UTF/INS/065/TNS: Forestrv Studies. 36 several well-publicized applications in recent years will have bad some impact on concessionaires' awareness of their responsibilities. 3.52. As noted above, the Ministry is also encouJ;aging considerable field experimentation in new systems of forest management, and most major donor agencies involved in the forestry sector in Indonesia are participating in this. The Bank is currently supporting, under its Second Forestry Institutions and Conservation Project (FICP ll) with GOI, a major concession management component. Under this project, improved procedures for forest management, log movement management and tracking, and revenue collection, will be implemented in three forestry regions. At the time of writing of this review, a detailed proposal for an improved system, jointly prepared by consultants and the Directorate General of Forest Utilization in the Ministry of Forestry bad been presented to GOI, and, by and large, the principles of that proposal bad been accepted by the Ministry. The identification of problems in field management, and proposals to improve matters given below, draws heavily on this proposal, with some additions or variations based on the Bank's sector review mission findings, and information or analyses obtained from other sources in Indonesia. 3.53. The private sector. There is the somewhat unusual situation in Indonesia whereby the private sector, in the form of the Plywood Manufacturers Associates (APKINDO), bas a major role in deciding upon issue of export licenses for plywood. This is potentially a powerful instrument for improving responsibility in the logging sector. The private sector bas the resources to collect information and monitor field operations in its own right, and, provided it bas, at industry association level, a strong commitment to long term use of the natural forest resource, its ability to exact censure on recalcitrant field operations through export license cancellation, is significant. It bas even been suggested that the private sector could effectively manage the production forests of Indonesia (see Box 3.2), and while a decision to do so would require very careful consideration, the considerable capacity of the private sector to positively engage in the regulatory process should not be ignored. 3.54. The regulatory base. A very extensive body of law and regulation exists to cover natural forest operations in Indonesia. Following issue of the Basic Forestry Law in 1967, and Presidential Decree No. 20 outlining the policy for granting of concessions, there have been more than 20 major decrees from the Ministry of Forestry on issues dealing with the many aspects of renewal, planning and operations of forest concessions; with additional decrees and regulations relating to forest land use from other Ministries, with at least a further 15 decrees and laws (including Presidential Decree No. 32 on protected forest management; and GOI law No. 5 on natural resource conservation) dealing with forest silviculture, conservation, environment and social issues. 3.55. Obviously, with such a large body of regulation in place, it is impossible to summarize its overall direction or intent - indeed, it is by no means a simple matter even to accum~late and absorb the full measure of this material. There are significant numbers of Ministry of Forestry staff at the central level involved in many aspects of preparation and promulgation of regulations and, presumably, a significant investment of the time of officers at the Kanwil and Dinas levei of operation is made in interpreting such regulations. At some point, in any administrative system, the burden of regulation becomes overwhelming: individuals responsible for field implementation of policy either become engrossed in acquiring knowledge of and interpreting regulations, or resort to selective application of what they know: a form of behavior which is usually accompanied by a strong tendency to pass responsibility for as much decision-making as possible to higher level officers, so as to avoid the risk of misapplication of regulation, or of making decisions without sufficient knowledge of what is intended under current regulation applying to the area in question. 3.56. There is evidence, of an ad hoc and anecdotal nature, that this point may have been reached in the administration of forest policy in Indonesia. This situation is complicated by the uncertainties that arise from the division of responsibilities between Kanwil, Dinas and lower levels of administration in the field: for example, there appears to be no clear allocation of all policy and regulatory development and promulgation to Kanwil, and field operation responsibility to Dinas - or some other such division of functions. The result 37 Box 3.2: ONE VIEW OF THE ROLE OF THE PRIVATE SECTOR IN INDONESIA'S FORESTRY MANAGEMENT •A total of 143 million hectares of forest area, or 74J'ercent of lndones1a'stotalland area, 1s under the jurisdiction of the Ministry of Forestry. This is an enormous area to survey an administer. One solution to lighten the govemment'sburden would be to tum the administration of the production forest areas over to the people who would benerit most: the timber companies. Two dccadea ago, such a proposal would have been unthinlcable. But as umber products develop tnto Indonesia's second largest export, and wnh scores of multi-million dollar plywood factories and pulp mills on the books, the bottom line on the balance sheet is clear. The very forest leaseholds we are harvesting today must be harvested a gam tn 35 years to ensure a constant supply of raw marerials. The contmued profitability of Indonesia's timber compames is now directly dependent on the contmued viability of our rainforests. The pnvatc sector can complement the. government's efforts-and in Indonesia it has done so-in at least s1x areas: 1. Forest Administration and Maintenance. The timber companies through their associations are willing and able to asaume many of the forest maintenance and admtnistrative functions which are currently the responsibility of the government. At least the 64 million hectares designated as cqmmercial production forest could be managed by the private sector. 2. National Forestry Inventory. One important function would be to survey the 64 million hectares of lndoneslll's production forests. Much of this vast expanse of rainforest remams uncharted. The private sector has through the Assoclllt1on of Forest Concessionaires sponsored nationw•de aerial photography surveys, satellite •mage proccssmg, and ground vertitic:ataon to determine the precise area of forested land and species distribution. With this comprehensive date base, m the form of aerial photomaps, supplemented With uncontrolled mosa1c maps. contour and vegetation interpretation, the government will be in a better pos1tion to update and refine the genera! policy regardmg the archipelago's forests. 3. Research. The forest industry can sponsor much of the basic forestry research itself, as this will translate into profit somewhere down the line. In Indonesia, the research efforts of timber mdustry are coordinated by the lndonestan Forestry Community to increase efficiency and eliminate expensiVe duplication of effort. The Indonesian Forestry Community is also inStrUmental in cementmg research cooperation with fore1gn mstituttons and agencies. Research programs being Implemented include investigation of lesser-known spec1es, mcreasmg y1elds through effective forest management, improvmg log transport to reduce wastage, propagation of dipterocarps, commercial production of micorrhiza, and determining the nght species for certam timber estates areas. 4. Human Resources Development. Private industry can play a role by setting up in-house training programs, tcchnica.l studiea institutes, and scholarship programs for overseas study. The Indonesia Forestry Communny prov1des scholarships to forestry students at severa.l nauonal umversltles: this is combined wtth on-the-JOb tratning for final-year students to familiarize them with their future employment. 5. Tunber Estates Transmigration. The Indonesian transmigration program is designed to shift farmers from overcrowded Java to the relatively underpopulated outer tslands like Kalimantan. This is a massive and expensive undertaking. TheJ'nvate sector's ttmber estate development programs take some of this burden off the government. The umber compan1es buil accommodations and other commumty factliues for arriving transm1grants, who then work on the umber estates for a spec1fied period. Their fam11ies are given a piece of land to work on. An additional one hectare is planted by the timber company with rubber trees. While the latex IS for the transmigrant, the harvested rubber logs arc for the company. 6. Public Information. To keep the envll'onmcntal issue concernmg the tropical forest m pcrspecuve, public information activities arc necessary. Although the government dctermmes how lndones1a's ramforcsts arc used, the Indonesian Forestry Community feels obliged to prov1dc the nght information and to explain and jusufy the government's ramforest policies to the world commumty. This JS one area where the private sector has assumed the public educauon role. The potentlal wealth locked in our tropica.l rainforests is immense, so are the difficulties in releasmg those riches in a sustainable manner. Only through cooperatiOn between the government, private industry and the scicnulic community, can the rainforest help support the nauon 's development effort. • Mohammad Hasan, Chairman, APKINDO. is that responsibility and accountability for some important functions are not clearly allocated, but are diffused among different agencies. There may be some agency funding implications involved here: indications were given to the Bank sector review mission suggesting that Dinas offices, while appearing to be fully staffed, do not have the means to train and fully mobilize staff. Since it is the Dinas offices which have primary responsibility for field implementation of compliance, the implications of this (if true) are serious. 3 57. Although there is general awareness of this problem throughout the various agencies involved, there appears as yet to be no real consensus, at an operational level, as to location of specific responsibilities and accountability. It may be that, before such an allocation (ana whatever human resource restructuring is implied by it) can be made, some attempt to simplify regulations - or at least to codify a central core of priority regulations to be applied vigorously -will need to be made. 38 3.58. Forest Management and Planning Issues. The issues of current importance in forest management and planning are: • The data bases for planning are weak: although inventories and cruising are ealled for at various stages of. the management planning process, implementation of this requirement at field level is poor: the FICP n concession management draft proposal cites a comparison of results from: 5 year working block inventories; 100% cruise of annual working blocks; and residual stand inventories; for common sites on several concessions, which clearly indicates that the data compiled are in each case extremely unreliable. This weakness also applies to estimates of nucleus trees on regenerating stands, leading to uncertainty about the level of stocking available for subsequent cutting cycles. • The use of square working compartments, instead of boundaries defined by natural features, makes control difficult. This is exacerbated by the lack of adequate information on what might realistically be expected in the way of increment from logged over stands, thus further compromising calculation of annual allowable cut. Further, the problem noted in para 2.10 above, that TGHK maps do not include identification of environmentally sensitive areas, is relevant here. • Problems of incentives and motivation of concessionaires to manage operations according to genuinely sustainable criteria are exacerbated by insecurity of the concession land ~e (this matter arose in the discussion of the KPHP option in paras 2.15 to 2.17) - including the lack of guarantee that any part of the concession will be available to the incumbent concessionaire at the time of the subsequent logging cycle. It is not possible to estimate with any accuracy the extent to which concessionaires currently comply with their agreements, but some survey work on this matter by the Ministry of Forestry suggests that in fact a majority do not. 3.59. Although precise data cannot be obtained, some post-logging surveys indicate that damage and mortality to residual growing stock is in the order of 35% -50%. On hilly sites (where much logging now occurs) as much as 50% of area is seriously disturbed, and only 20% remains undisturbed. 3.60. Silviculture. In theory, updating of original decrees on management and silviculture now provide for three possibilities for silvicultural management of natural production forest areas in Indonesia: (i) The Indonesian Selective Cutting and Planting System. (rl) Clear felling with natural regeneration. (iii) Clear felling with replanting. 3.61. In practice, only the Indonesian Selective Cutting aad Planting System is applied widely. This system, now known as the TPTl (Tebang Pilih Tanam Indonesia), which replaced an earlier system (the TPI) in 1989, is based on the assumption that a residual stand after logging will contain an adequate stocking of sound, commercial species trees of 20 em diameter at breast height (dbh) or more, which will grow into economically barvestable timber in 35 years from the original logging date. The TPTI system prescribes: logging down to a prescribed sized limit (50 em dbb in Indonesia at present); liberation thinning to release nucleus trees for re-seeding) and commercially valuable regeneration; inventory of residual stands; plantation of seedlings to enrich the stand if necessary; and subsequent tending and liberation thinning. 3.62. A great deal has been written, at operational, research and academic levels, about the selective logging approach designed to produce barvestable regeneration in 35 years or so, from sapling and pole sized material left on the residual stand. 39 3.63. Academic or research results whi~h contend the basic assumptions of the selective logging system usually question the vigor, or even the existence, of the growing stock which is supposed to become mature in 35 years. Dr. Sutisna of Mulawarman University in Samarinda has suggested that in Indonesia (specifically Kalimantan, where his research has been located) it is not always the case that the 25 nucleus trees of commercial species per hectare which are to form the basis of the harvest in 35 years time are available, or, if available, will necessarily survive: many have small crowns (because of their previously sub- dominant position on the stand), and are thin and susceptible to breakage. Field observations and discussions held by the sector review mission indicated that in some cases there would not be sufficient effective regeneration of sufficient size on selectively logged stands to guarantee a crop in 35 years, even if logging were carried out carefully (see Annex 2). 3.64. Putz and Ashton6 argue that it is almost never the case that a single silvicultural system can sensibly be mandated for a resource as broad and diverse as a tropical moist forest. They caution that the selective logging or polycyclic system will only succeed with intensive and skilled operational control and management, and only then in suitable stands. In some stands, they suggest: ".. the intermediate size classes are composed almost entirely of species that do not provide commercial timber. Harvesting stands poorly stocked with advanced residuals is tantamount to high-grading, results in stand deterioration (from a silvicultural perspective) and should be avoided." 3.65. At an operational level, reservations about the TPTI system per se center on the complexity of the system: especially, the difficulty inherent in controlling logging operations sufficiently closely to minimize damage to small trees which are to be the next 35 year crop. Observation in the field suggests that in practice, most logging operation damage residual stands to the extent where 35-50% of trees die (eventually): mortality is higher than this on hilly s~tes (where much current logging is taking place). 3.66 Another major drawback of the system is that it increases the temptation tore-log a regenerating stand prematurely: incomplete initial operations, or changes in acceptability of species or size limits, may justify early re-entry on commercial grounds, albeit that these are illegal, and are highly destructive of the residual stand. 3.67. Both of the above problems emphasize the fact that the TPTI system- inclusive of the follow-up monitoring requirement it imposes - is highly demanding of both concessionaire and forest agency human resources, and yet it is these resources which are currently in shortest supply. 3.68. There are some more implementational problems relating to the TPTI which would be overcome with changes in procedure: (i) Application of liberation thinning more or less automatically one year after logging should be replaced with a more flexible approach, determined by when weed infestation and seeding actually occurs on individual sites; (ii) Current requirements for inventory of the residual stand (to determine enrichment planting needs) are extremely time and resource consuming. This means that in practice few concessionaires carry out this work properly. Dinas and Kanwil resources in the field to inspect 6 Putz F.E and M.S. Ashton, 1992, The Ecology and Silv1culture of a Mixed Dipterocam Forest in South- east Asia. Unpublished paper comnussioned by World Bank and the International Tropical Timber Organization. and check such inventory are limited. !t would seem that some less resource intensive inventory or sampling procedure will have to be applied. 3. '69. If in fact the TPTI system is in g~neral not leading to regenerating stands in good condition for re-logging in 35 years, then this- combined with doubts raised in Chapter ll about the status of the remaining forest resource in Indonesia- raises serious likelihood of a shortfall, or resource gap, emerging at some point, unless production levels are reduced, so that supply can be spread over a longer period. 3.70. One way to achieve this would be to move to a 60 or 70 year regeneration cycle, based on seedling regeneration, rather than reliance on small trees. A variant of this is the shelterwood system, which prescribes establishment of a new, even-aged seedling based crop, under a phased removal of the old stand- the final phase being removal of the shelter trees needed to provide the seed and shelter for the.new crop. Of this system, Putz and Ashton (op cit, see pg.39) state: "Apart from being compatible with the natural regeneration processes of canopy tree species that are relatively light-remanding, shelterwoods can be more economically cost effective than selection methods. Several entries into the stand to extract commercial timbers are done over a relatively short period at the end of the rotation. If harvesting is controlled, there is little damage to the growth and development of the new stand, and costs are less over the long term for the administration and set-up of a timber harvesting infrastructure." · 3.71. The Ministry ofForestry bas acknowledged that such a monocyclic prescription may be·feasible for Indonesia. The ITFAP (op cit, on pg. 7) document calculated (on the basis of then current assumptions on growing stock) that a move to the longer cutting cycle would move the sustainable annual cut from 38 million cum pa, to 31 million cum pa - and the latter figure is the one adopted as the current sustainable cut in the ITFAP document. In that document, the Ministry of Forestry states: "There is a strong view that a 35 year cycle may be only about half the length of time required to support a sustainable harvest in the long term . . . . . •. Taking these views into consideration, TPTI will be continuously monitored and evaluated for its effectiveness in achieving sustainable management". (ITFAP page 55) 3. 72. As shown in Table 3.1 and surrounding discussion, even at the higher 53 em minimum diameter felling limit, the monocyclic alternative is comparable economically to the polycyclic system. Since a monocyclic system is based on seedling based regeneration, no silviculturally based girth limit on logs taken at the first harvest is necessary: the only limit on what is taken from the forest is what can be marlceted. So, it can safely be assumed that, these days, logs of commercial species down to 35 em dbb can be marketed. This, combined with improved logging utilization, will lead to a reduction of only about 8% of volume overall from the current resource under the monocyclic system, compared to allowable cut under the polycyclic system. One immediate management benefit from such a change would be that areas needed under logging at any given time would be greatly reduced (since per area volume off-takes will rise greatly) - thus reducing working areas to be inspected and controlled. 3.73. In addition to the obvious issue of managing the TPTI system, and the risks of insufficient regeneration to allow Jogging 35 years after the initial cut, there are the larger economic and environmental issues involved in this question: the impact of national and global environmental concerns on the calculations. These were dealt with in paras 3.16 to 3.27 and on those grounds also, the monocyclic system, with reduced minimum felling size appears to have some advantages. Further discussion is included in Annex 2. 3. 74. Log management. The systems which monitor and control Jog production and revenue calculation and collection are as vital to the sustainability of the forest resource, as are field management and silviculture issues. Already, in paras 2.27 to 2.29, the issue of illegal removals bas been raised: clearly, 41 unrecorded and uncontrolled extraction at this lev~! has serious implications for the condition of the resource. Equally important to sustainability is that the proper value be assigned to logs - a matter not only of overall economic rent recovery (see Chapter V) but also of the means by which logs are scaled, graded, classified, and their movements documented. 3.75. Some of the major issues which emerge for log management are: The responsibility for payment of royalty and reforestation charges depend on whether the concessionaire is integrated with a processing plant: if so, the plant pays, if not, the concession pays. Charges are assessed at two locations. This system appears to create unnecessary complexity. Although control systems are in place, significant illegal log traffic takes place. Because in some cases log charges are not levied until material reaches a designated mill there is opportunity for leakage of "volume to illegal processors before that point. A comprehensive system of log records and management reports exists and should minimize this, but reports are not always submitted on time in practice, and an integrating data base to allow a consistent data set from one office and location to another does not exist. Since July 1992, industry bas had the responsibility to "self-assess" - concessionaires and converting mills provide a monthly report to the sub-district forestry office, showing volumes shipped, and fees paid into bank accounts. Justification given for this somewhat unusual system is that it minimizes contact and opportunities for collusion between forestry officials and industry: officials inspect and check invoices, but do not compile them. Some early field indications apparently suggest that overall revenues have in fact risen somewhat since introduction of the system, and it should perhaps be monitored for a ·longer period before judgement on its effectiveness is made. In the long run, it will place a heavy onus on GOI to reconcile any discrepancies which emerge, and prima facie, seems no less open to abuse than the previous system. It is in the area of log control and management where most opportunity for malfeasance arises. The officers most directly responsible for checking log measurement and revenue calculation are relatively junior, poorly paid (and with inadequate travel and other allowances), and (often) ill - equipped in terms of training and means of transport to perform their function. Relatively little cross-checking of initial records appears to be done, although the procedures and mandates exist for this to happen. Staff of the Inspector General of the Ministry of Forestry perform audits of Dinas, Kanwil and Ministry operations, but this procedure seems mainly confined to audit of expenditure, rather than of field performance of Jog management and movement monitoring procedures. 3.76. A great many suggested changes in the detail of how log management is done in Indonesia are put forward in the proposals presently being considered for implementation under FICP ll, and an opportunity to refine these will exist in the three Province field implementation of the proposals. One overriding issue which will clearly emerge is that of inspection. There is little doubt that, with the refinementS and changes proposed, the existing system of inspection at Dinas and sub-Dinas level could work. It is equally evident, however, that this will require implementation of very strong policy imperatives for reform of the system. It may be that, to bridge the period between the presently poorly functioning system, and field implementation of the new system, a centrally based and powerfully mandated inspection service may be required: one capable of random inspection of all aspects of foro...st and log management, with access to sanctions on concessionaires and performance of Kanwil and Dinas officers as well. Initially, such a system should concentrate upon certification of sustainability criteria (see paras 6.67 to 6.73 below), with a strong advisory role insofar as correction of procedures and performance is concerned. Ultimately, however, one of its purposes should be 42 to apply disincentives for inappropriate behavior, in addition to providing certification for operators who are in compliance with guidelines. The Plantation Sector and the HTJ Scheme 3. 77. Government plays a strong role in the plantation sector, and this role is financed under the Reforestation Fund (Dana Reboisasi). This fund is formed by a fixed levy of $15.00/m3 (raised from $10.00/m3 in early 1993) for ply and sawlogs, and $1.50/or for pulpwood material. No precise estimate of the current size of the Fund is available: some $900 million appears to be in the Fund now; some $125 million has been allocated so far to companies, in equity or loans. Under the terms of Presidential Decree 29/1990, the fund may be used to finance: reforestation outside concession areas (known as the Regreening Program); plantation establishment on unproductive forest lands (the HI'I program); rehabilitation of land (the Critical Watersheds Program). 3. 78. The liTI program. Of most direct policy interest in this review is the HTI scheme: the means by which Government finances private sector planting in Indonesia. In REPELITA IV (1984/85- 1988/89), the Government introduced the Hri scheme, to encourage the establishment of a large, private sector based industrial forest estate. The Scheme has the stated objective of utilization for plantation forest land in the outer islands no longer capable of carrying commercially sustainable natural forest. 3.79. Official targets for the Hri in the 1989-1994 (REPELITA V) period sum to 1.5m ha. Figures released by the Ministry of Forestry reveal that some 574 000 ha had actually been established under the scheme, by June 1992. 3.80. According to the ITFAP (op cit, on pg. 7) document, the Government intends to have 2.3m ha of plantation established under the HTI scheme by 2000 AD, and 10.5m ha by 2030 AD. The latter figure tallies with the current estimate given (see para 2.4) of logged over forest in Indonesia although only half of this is said to be in a heavily logged over state. The ITFAP document notes that the intention of Government is to have some 60% of total planted area under longer rotation timber species by 2000 AD, and 80% by 2030 AD. To date, however, the bulk of investment has gone into short rotation pulpwood species. So far, some 33 pulpwood Hrls, each of 300,000 ha have been identified. Although a pulpwood concession over 300 000 ha is issued, the intention is to plant only some 60 - 80,000 ha of this area. The remainder of the area is to be logged (usually this is re-logging, since the areas concerned are logged - over sites) for pulpwood, to supply the designated mill operation until the pulpwood supply from plantations comes on stream. The subsequent status of this hinterland area, and what is to be done with it, is unclear. It appears that most of the decision as to where plantation will be located in the HTI concession is left to the concession holder to make. These questions do not seem to arise for sawlog HTis, w~ich are issued for 60,000 ha blocks, all of which is intended to be planted. 3 .81. Prior to 1989, the HTI scheme required natural forest concession holders to implement plantation activity on behalf of the Government, as part of the concession agreement. This approach failed: only small areas of plantation were established, and stand quality was low. 3.82. In 1989, a new approach was introduced, whereby a land use right, in the form of a Hri concession is granted, with an undertaking that the developer will have the rights to the wood produced. The length of the concession granted is 35 years plus the time taken for one rotation of whatever species are planted: this tenure is at variance with the more limited time frame of natural forest concession, of 20 years. Official policy designates that forest areas of low productivity (generally interpreted as less than 20 cum standing volume per hectare) are to be used. A concession over such an area is issued by the Ministry of Forestry, on the recommendation of the Provincial Governor and following submission of an application and 43 a satisfactory feasibility study (including trial plantings). A HTI concession does not transfer ownership of the land, is not transferable (except under specific approval of the Minister) .and cannot be used as collateral. 3.83. In 1992 the Government introduced a variant of the scheme: the HTI- Transmigration scheme. This allows a clear-felling license over 3000 - 15,000 ha on a HPH site, provided that 10% of the area is reserved for transmigration purposes. The joint venturing and other arrangements are more or less as defined in the regular IITI. Some 630 000 ha of land has been allocated under this scheme, as of October 1992. 3.84. There is as yet no umbrella organization representing HTI holders, although most are associated with the Concession Holders Association (APHI), and many also with APKINDO (the Wood Panel Association) and/or ISA (the Sawmiller's Association). The Economics of the HTI Scheme 3.85. Two major questions arise out of current practices in the HTI scheme in Indonesia: (i) Is subsidization necessary to create large private sector pulpwood resources in Indonesia? (ii) What are the options for use of HT1 hinterland - ie those areas currently included under HTI pulpwood concessions which will not be planted, but will - after logging for pulpwood- also be in relatively poor condition so far as prospects for natural regeneration are concerned? 3.86. Financing the IITI. The package offered under the HTI scheme, to qualified private investors, is a joint venture with Government, financed as follows: • Government finances and takes equity of 14% (held by one of the state owned forestry companies (INHUTANI)); • The investor provides 21% of direct equity; • An interest free loan to the investor of 32.5% of the cost of the project is provided; • A commercial loan to the investor of 32.5% of project cost is underwritten by Government. 3.87. CooperativeS in Indonesia are eligible to apply for HTI loans. The Inhutanis which take equity on behalf of GOI are able to finance that equity from interest free loans from the DR fund. 3.88. At current high real market interest rates in Indonesia, the subsidies provided for under the HTI are generous. Recipients are entitled to 60% equity in the plantations established. With some manipulation of costs below threshold levels, it would be possible for investors to finance their equity at relatively little cost. 3.89. The economics of Pulpwood Supply. A review of the economics of plantation in Indonesia given in the FAO Studies (1991) indicates that on average, pulpwood regimes in Indonesia can be expected to generate real returns in the order of 15% p.a.; while longer rotation sawlog/plylog regimes are expected to generate returns in the order of 10% per annum, provided intermediate thinnings can be sold as pulpwood. The pulpwood returns are borne out by the NPV calculations discussed in paras 3.93 to 3.97. However, it appears from these calculations that sawlog/plylog plantation produce returns superior to the F AO estimates. A return of 15% p.a. would in most circumstances be regarded in Indonesia as unacceptably low- especially in a relatively new venture with some risk attached. This rate is based on at-mill pulpwood prices in the order of $16-$20 per cum, and the question arises whether these are realistic. 44 3.90. Pulpwood plantations in Indonesia are a small proportion (around 10 -15%) of investments in the pulp and paper sector as a whole. This means that the economics of pulpwood planting will be heavily dependent on the economics of the manufacturing investment. Hone7 has noted that: - " "A combination of 15 percent lower prices for market pulp and weak demand giving only 8.:>-90 percent capacity working would reduce a mill's internal rate of return by 4-5 percent, and severely impact on financial viability, even if very low wood costs were achieved." (emphasis added). 3.91. Hone cites a calculation which shows that a 10 percent escalation in mill capital costs, or a 10 percent fall in receipts per ton of pulp each reduce the internal rate of return by approximately 1 percent. On the otherband, a $5/cum rise in the delivered cost of pulpwood to a pulpmill (and, from the viewpoint of the growing sector this would be a substantial rise) would reduce its overall rate of return by only 0.1 - 0.15 percent. This raises the question of pulpwood exports, as a possibility. It would seem, at the delivered pulpwood cost estimates current in Indonesia, that some of the material could be sold to export - probably (although not necessarily) from additional chipping capacity which could be established at pulp and paper mill sites, so as to take advantage of existing handling and sea transport infrastructure. Presumably, existing Indonesia log export tax policy would preclude such a development, but it would be relatively simple to make an exception for pulpwood or chipped material, thus giving both plantation investors and pulp manufacturers expanded options. 3.92. Provided that the pulp and paper sector is economically viable and efficient at the size projected, then the mills constructed should be capable of paying prices for pulpwood sufficient to allow well-located and efficient plantation of pulpwood to generate reasonable returns. Some figures cited in Chapter IV (see para 4.88) suggest that Indonesian world scale mills being planned will be highly competitive internationally, and should be capable of paying unsubsidised costs for their pulpwood. While there may initially have been some justification for subsidization of pulpwood plantations to attract investors into the sector - largely on the baSis of underwriting the risk of this relatively new venture - investment in major paper-making capacity in Indonesia would now seem sufficiently advanced 8 for such subsidies to be neither necessary nor particularly effective. Where relatively good sites, chosen by investors themselves, are under consideration, it may be that all Government needs to offer large pulp and paper sector investors is security of tenure over sites - either for their own development, or allocation to other groups under some form of guaranteed supply arrangement. 3.93. Plantation options for the HTI hinterland. The question of what should be done with the large areas surrounding pulpwood plantations on liTI concessions is a complex one: there will be a range of sites involved, from effectively recovering natural forest to completely open areas. The following analysis is intended to show differences between different plantation options on open sites, and then to show the implications of planting over areas that may be recovering to naturally forested condition. 3.94. As in the case of the natural forest management options examined earlier, outcomes are analyzed here from the private, national and global viewpoints. Three generic possibilities are examined (again, the details of assumptions and data used to formulate these are given in • Annex 1): (i) pulpwood plantations of fast-growing species on an 8 year rotation; 7 A. Hone, 1992, unpublished working paper. Four or five large pulpmill projects have already reached site preparation stage in Indonesia. Six af681 world scale mills could well be built by 2010 AD. 45 (ii) utility sawlog plantation of fast g(Owing exotic species on a 10 year rotation: (iii) integrated plantation of native Dipterocarp species under fast growing exotic shade trees; shade , tree harvest at 8 years, and Dipterocarp harvest at 25 years. 3.95. The results ofthe financial assessment of industrial forest plantations are presented in Table 3.6. The estimated financial returns to the various types of forest plantations are quite favorable, generating NPVs of from approximately $500 to $1900 per hectare. High returns to short rotation sawlog plantations arise because -sawlegs are worth $25 to $40 per cum, compared to $20 - $25 per cum for pulplogs - but cost only about the same to grow: profits are thus much higher. Even if the sawlog rotation length is extended to 15 years, the financial NPV for sawlogs drops only to $1300 per ha - still much higher than the pulpwood regimes. As noted earlier, the financial-viability of plantations is highly dependent upon their location, which can provide low-cost access to marlcets . .The lower value of plantation wood suggests it can support only modeSt ·transi;ort costs. A pulp plantation is not financially viable without ready access to a pulpmill. Similarly, plantations producing relatively low value sawlogs must have markets (pulpwood or fuel wood) for ·its thinnings and ready access at low transport cost to markets for both the sawlogs and thinnings. Hence, in general, lo_cational considerations will be even more important for plantation wood than for higher-value naturai timbers. 3.96. As shown in Table 3.6, the total returns (NPV) to plantation forests increase as the social and global returns aie added to the financial. This is because, starting from an assumed highly degraded site, the forests provide local and global environmental services as ~ey grow, as well as increased financial values. Table 3.6: SUMMARY OF FINANCIAL, SOCIAL & GLOBAL RETURNS: INDUSTRIAL FOREST PLANTATIONS (ON ABANDONED AGRICULTURAL LAND OR ALANG-ALANG GRASSLAND) (NPV AT 10% US$/HA) Criteria Regime Net Present Value of Pulpwood, Sawlog, Saw/Veneer, Years 1 to 70 8 Yr. 10 Yr. 27Yr. - Fmancial NPV $476 $1950 $1088 Social NPV 476 1951 1095 Global NPV 702 2153 1367 This contrasts with the natural forest situation examined earlier, where the initial harvest itself creates negative social and global values even as it is generating financial values. It is interesting to compare NPVs of the forest pla~_tation options (Tables 3.6, 3. 7) with those of regenerating logged-over forest (Table 3.2), which many pfariilitioifs replace. Although the financial returns of plantations are superior to those of natural forest manigeriie~f iri all cases, when social and global values are included, the economic returns of natural forest management~ those of pulpwood piantations. The returns to investments in sawlog plantation exceed those-o'filatural forest management from both the financial and social perspectives. However, from the global perspective, natural forest management of logged-over forest is superior to plantations of native dipterocarp plantations for production of veneer logs. 3.97. If native forests (including regenerating logged-over forest) are removed to make way for forest plantations, the net effects would be vastly different - the social and global environment values lost by clearing will be significant. Table 3. 7 presents estimates of returns to planta!!~~ for th~ alternative plantation cases on logged-over forest land. Although financial returns (line 1) increase due to revenue from pulpwood salvaged during clearing of the residual forest, social and global returns (lines 2 & 3) to forest plantation on 46 logged over forest capable of regeneration are significantly lower than those for plantation of abandoned or alang-alang land, where no environmental values are lost in plantation. Table 3.7: SUMMARY OF FINANCIAL, SOCIAL & GLOBAL RETURNS: INDUSTRIAL FOREST PLANTATIONS (REPLACING LOGGED-OVER FOREST) (NPV AT 10% US$/HA) Criteria R~imes Net Present Value Pulpwood, 8 yr. Sawlog, 10 Yr. Saw/Veneer, 27 Yr. of Years 1 to 70 Fmancial NPV $626 $2100 $1238 Social NPV $370 1845 988 Global NPV (324) 1127 341 liTJ Scheme Implementation and Observations 3.98. Environmental and technical clearance. The technical processes of approval of a HTl scheme is comprehensive: applicants for pulpwood plantings are required to undertake a pre-feasibility study. This study is submitted to a Ministry of Forestry team and to the Kanwil Kehutanan offices, which then make recommendations on the application to the Provincial Governor, who in turn makes recommendations on the project to the Minister of Forestry. The applicant must then undertake a feasibility study (which requires clearance by the Director General of Reforestation and Land Rehabilitation in the Ministry of Forestry), and trial plantings. 3.99. One potential shortcoming of the process as currently designed is that the trial planting stage can be implemented before full consideration- by the investor and the Ministry- is given to the results of the feasibility study. Issue of the trial planting permit involves considerable work for the Ministry of Forestry and, obviously, trial plantings represent a considerable financial commitment for the investor. It is therefore a stage which should only proceed once the financial, environmental and social implications of the project are fully considered in a feasibility study. 3.100. Environmental assessment is a particular case in point, in this respect: in general a full environmental assessment under the Environmental Impact Assessment (AMDAL) procedures issued by the Ministry of Population and Environment, will be indicated for a HTl. However, there are some unresolved issues in this area: First, although guidelines for assessing the impact of a liTJ have been issued by the Ministry of Forestry (DG Forest Protection and Nature Conservation), these guidelines are somewhat general: few specific technical standards or criteria are provided. Second, although a full assessment is generally warranted under the AMDAL guidelines, it appears that in practice in some cases only preliminary assessment is done. Third, the timing and commitment problem referred in para 3.99 above applies, in that environmental assessment results may not be submitted (as part of the feasibility study) until after trial plantings have been initiated. This is too late in the process: it is difficult and expensive for permission to proceed to be withdrawn once substantive field investments are made. 3.101. The HTl scheme as presently designed appears not to restrict potential investors from converting land under forest plantation to other uses, after a rotation or two. In itself, this may not be an undesirable outcome, but the Government may wish to have a larger role in this decision, or at least to ensure that the terms of the liTI do not simply offer potential investors in other forms of land use a lower cost access to the land than would apply otherwise. The downside risk in this situation is that such investors will minimize 47 commitment to forest plantations (including investment in necessary research, development and quality improvement), seeking only to qualify themselves for access to the land under long lease, financing the plantation primarily from the concessional terms offered under the scheme, and then proceeding to conversion as soon as possible. 3.102. There is no systematic evidence one way or another that the HTI scheme may contribute to poor natural forest operations but, again, the scheme as presently conceived could allow this possibility. In the first place, it is not clear whether the criteria used to determine forest land which is unproductive (and therefore qualified for HTI conversion) infer anything in particular about the capability of the site to regenerate natural forest cover (possibly with some intervention at initial logging, if justified), even if the residual stand is currently of low density. Secondly, the very existence of the HTI scheme in its current form as a follow-up activity after logging could discourage supervision of standards on some sites being logged, in effect making the subsequent classification of those sites as 'unproductive' a self - fulfilling prophecy. 3 .1 03. It is also not entirely clear what will happen to the hinterland areas in a HTI: that part of the 300 000 ha or so concession which is re-logged (assuming it to be a residual low density natural stand) for pulpwood as an interim measure until the plantation pulpwood stands mature. Clearly, after logging for pulpwood, little prospect of natural regeneration will exist, and most of the site will not be planted to pulpwood (since only 60 000- 80 000 ba is intended to be planted). Unless a comprehensive plan to develop the whole site is an integral component in a HTI scheme, it would be preferable to award smaller plantation areas to investors not dependent on utilizing the surrounding resource. 3.104. However, in terms of aggregate forest impacts, some perspective on the implications of natural forest pulpwood use is neces~ary. The volume of natural forest pulpwood needed to provide start up volume will depend upon the rate at which new capacity comes on stream. Hone (op cit on pg.44) estimates that if all scheduled mills come on stream, then 25-30 million cum of natural forest hardwood pulpwood would be required from 1992-2000: after 2000, it is presumed no further use will be made of natural forest for pulpwood. Depending on the types of forest area used, and the nature of operations this would imply pulpwood extraction from 150,000- 300,000 ha in total over this period. 3.105. It seems unlikely, therefore, that all areas of natural forest allocated for pulpwood extraction as interim supply under the HTI scheme will be needed for this purpose. This estimate also raises a question as to whether a Ministerial Decree (44211992), which provides that all production forest, regardless of conditions, within 100 km of a planned pulp site may be used for HTI development, is either necessary or desirable. 3.106. The level of future supply. It is difficult to predict whether, under current implementation of the HTI scheme, oversupply of pulpwood will result in Indonesia. Some insight can be gained from a review of the projected size of the pulp and paper sector (see paras 4.88 to 4.93). Pulp and paper making capacity in Indonesia is projected to rise from 1 million air dry tons pulp p.a. and 2 million metric tons of paper making p.a. in 1992, to 5.5 million ADT and 7 million Mt respectively by 2020 AD. Using a standard conversion factor (1 ton of air dry pulp requires 4.5 cum of pulpwood) this implies pulpwood requirements for pulp and paper making will rise from 4.5 m cum to 25 m cum over the some period. Assuming fairly conservative plantation mean annual increments of20-25 cum/halannum, Indonesia could supply its hardwood fibre requirements for its pulp and paper sector from about 800 000 hectares of plantation by 2010, and 1.0- 1.2 m ha by 2020. 3.107. Hone (op cit, on pg. 44) suggests that, on current pulpwood plantation projections, oversupply is likely. However, this claim seems based on the assumption that each HTI will establish 100 000- 200 000 hectares of planted area. As pointed out in para 3.80, in the case of pulpwood HTls, the likelihood is that only 60,000- 80,000 of the 300,000 ha allocated in each case will be planted. In the ITFAP (op cit, on pg. 7) document (ITFAP pg.59), projections are provided which indicate that by 2000 AD, 2.3 million hectares of 48 industrial plantation will be. established, of which 40% (920 000 ha) is expected to be pulpwood. It seems unlikely that the sawlog/plylog component in this projection would eventuate unJess policies change: although returns to sawlog plantation (see paras 3.82 to 3.87) are quite attractive, little interest is apparent as yet. This is due to the attractiv~ness to investors in pulpwood HI'ls of gaining long term access to the large hinterland. The pulpwood component, if achieved, would not differ radically from the figure of 800 000 given in para 3.105. If, however, all of the 33 pulpwood liTis which have already been allocated by the Government, were to establish 60,000 - 80,000 hectares of plantation each, then 2 to 3 times the volume demand projected by Hone for the pulp and paper sector would result. It may be in Indonesia's interests to level the playing field between sawlogs/plylogs on one hand, and pulpwood on the other: see para 4.20 for an example supporting this. Some Conclusions on the liTI Scheme 3.108. The question of how much and what type of plantation should be grown in Indonesia, and where these ought to be located, is one which properly should be left primarily to the private sector. The job of the government is to decide in broad terms upon locational and environmental conditions, and then to implement a policy and ineentive structure which encourages investment compatible with these. Presently, the Ministry of Forestry is working on a Master Plan for plantations in Indonesia: consultancy inputs for this study are being financed under the Bank-GO! Second Forestry Institutions and Conservation Project. This exercise will yield valuable land capability, locational and economic information, so that establishment of priorities and ground rules should become more straightforward. 3.109. The analyses and observations presented above on the plantation sector lead to the following conclusions: (i) While some subsidization of pulpwood plantation on existing sites may in the past have been warranted, given that the govemtnent had decided upon a major expansion of the pulp and paper sector, such subsidy is no longer desirable or necessary. If sites chosen by existing or potential liTI investors are to be planted, the role of government is to assure secure title (see the following section on community issues), and possibly to assist with plantation research, given the public good nature of such research. (ii) Given the apparent environmental gains that are generated by opting to plant abandoned areas (see paras 3.93 to 3.97), the government may be justified in encouraging plantation on such areas, to induce investors to choose such sites. Such an option could, apart from anything else, encourage investors with no current access to forested land through natural forest concessions (since presently HPH concessionaires tend to be primary candidates for HI1 concession awards) to pursue plantation forestry: sawmillers and secondary wood processors could be included in this group, as could local community groups with the necessary capability and interest. a Obviously, pulp and paper processors who chose similar course would also be eligible for whatever incentives apply. The incentive structure applied should, as in the present case, emphasize security of tenure, assistance with research and technology, given the public good nature of these. Subsidies could be considered if the national gains in plantation of such areas exceed the level of subsidy needed to encourage private investors - but other measures should be explored first. (iii) Procedures for environmental clearance for HTI projects need tightening and reorganization. A particular area of concern is the hinterland surrounding plantation sites, allocated for interim supply. It seems unlikely that all such allocation, would be needed for such supply, and that inadequate incentive to extract pulpwood efficiently from such sites are presently in place. 49 Forest Communities: Ri2hts and Sustainabilitv 3.110. It is becoming increasingly clear that in the outer islands of Indonesia, communities (indigenous or recently immigrant) which depend to a significant extent on the natural forest will exercise a strong influence on forest management - especially on what occurs on forests after logging programs have been carried out. 3.111. Although no systematic study of the activities and aspirations of forest dwelling and adjacent communities has been done, it became apparent to the sector review mission on field visits that there is some conflict between communities, government agencies and the private sector arising from field forestry operations, and there is a need for improvement in the processes of prior consultation with communities likely to be affected by forest operations, and.of defining and disbursing compensation, where this is agreed to be the most appropriate approach. 3.112. The extent of community- occupation. As noted in para 2.17, the area of forested lands currently occupied or claimed by forest dwelling or adjacent communities is unknown. Nor is there consensus on the size of forest dwelling and/or forest dependent communities in Indonesia. Demographic data from the Human Relations Area Files (HRAF) at Yale University are not yet available. Data from Harvard's Cultural Survival tapes do not specify size of occupied area. 3.113. The Indonesian Department of Social Affairs Directorate of Development for the Most Isolated Peoples (DBMT) uses a highly restrictive definition of isolated people, which excludes many current forest residents. It estimates an isolated forest dwelling population of 1.5 million people. Some recent estimates made on the basis of including all people who can be classified as dependent on forested areas regardless of their ongin (and therefore, including transmigrants and other relatively recent immigrants), conclude that as many as 65 million people in Indonesia might be in this category. The Ministry of Forestry has estimated that around 22 million people may be engaged in swidden agriculture on lands under its jurisdiction in Indonesia, while the Re PPProT study of 1991 estimated around half this number for swidden agriculture. 3.114. It does seem reasonable to argue that, whatever the precise numbers under various definitions eventually tum out to be, they will be significant. It seems clear that many millions of people inhabit Indonesia's forest areas, and exercise significant influence over land use options in that area. Their interests should be represented in land use decisions, but the lack of data on spatial and demographic dimensions of forest dwelling and dependent communities will prevent this. Thus, the lack of data will undermine the achievement of sustainability in forest operations, and at conservation of biodiversity and improvement of welfare in these communities. 3.115. The impact of communities on forest areas. In para 2.24 above, it was suggested that the role of traditional agriculture - including slash and burn practices - might account for only 21% or less of total deforestation in Indonesia. In fact, the thrust of a good deal of recent study of this subject seems to be that, prior to intensive commercial timber operations, forest communities in Indonesia bad developed a remarkable set of agroforestry practices, under customary institutions and Jaws, and had produced a sustainable result in many instances. Even swidden agriculture- much criticized in academic and official circles some years ago - has fared better in recent research, which has shown that in many cases swidden practices do not exhaust soil nutrients·and cause erosion, and may in fact represent a reasonable environmental option in the humid tropics, given the combination of infertile soils, nutrient storag~ in biomass, and intense weed competition that applies. 3.116. It is clear however, that a good deal of once-forested land in the outer islands oflndonesia has in recent decades become degraded through various agricultural practices. Some areas infested by imperata grass (alang-alang) clearly were once forested, and would in that condition have nad more intrinsic value than the grassland, which contributes little or no economic value. This is the key in link.ing sustainability and poverty issues: it is not suggested here that sustaining forest areas must take precedence over poverty 50 alleviation. Rather, it is suggested the two issues· re-enforce each other: where sustainable forest use is the best usage of the land in question, from an overall economic point of view, there will be sufficient surpluses generated by doing so to compensate potential encroachers who would otherwise convert it. The only issue is whether such redistribution can be done effectively. 3.117. There are a number of explanations for adverse trends at present: introduction of inappropriate agriculture; sheer pressure of population leading to overuse; the simple increase in opportunities to utilize relatively infertile sites opened up by forest operations; and decay in customary ownership with its attendant responsibilities. It is likely that large scale forestry is implicated: it will displace forest dependent communities from significant areas, who must then find other areas to utilize; it does, in its role as a pioneer industry, open up tracts of land to external colonization - government sanctioned or otherwise; and, when undertaken without adequate consultation with and involvement of traditional owners and occupants of a given area, causes a breakdown in historically understood property rights and responsibilities. 3.118. This is not intended as a criticism of extensive forestry ~. nor as an appeal for rolling back sector operations. · It does serve to emphasize, however, that in the outer islands of Indonesia, forestry operations, in addition to their economic role, are a major agent of social and environmental change. Those who make decisions about such operations - both in the public and private sector - by definition must bear the responsibility for what occurs on forest areas subsequently: they cannot confine their concerns only to planning and regulation of the forest operations themselves. They must therefore be fully aware of the potential impacts of forestry operations on forest dependent communities, and be equipped with polices and programs to deal with these impacts. 3.119. The impact of forestry operations on forest dependent communities. Because, as noted earlier, areas designated as production forests overlap in many cases with areas in which forest dependent communities form, hunt, fish and gather non-timber products, it is obvious that a large extraction operation will have major effects. 3.120. It is not possible to quantify, in Indonesia, what proportion of forest operations have created significant adverse impacts on local communities. It is apparent, from the very extensive amount of case study and anecdotal material available, that such impacts are widespread and, in certain cases, serious. The case study and anecdotal material suggest the following major problem areas: • Although certain traditional or customary rights over forest areas may exist for local communities in Indonesia (see paras 3 .125 to 3 .127), in many instances the effect in practice of introduction of a HPH or IITI project into an area has been to disenfranchise traditional users of such areas, with resulting economic marginalization and displacement; • The processes of road construction, site clearing and so on have frequently destroyed areas already under traditional agricultural use; , • In some instances (especially in Kalimantan) water access to markets for traditional users has been obstructed by bridge work related to HPH operations. Water quality has also been affected by obstruction of feeder streams due to forest operations; and health problems have emerged. 3.121. There are numerous accounts of instances where HPH and HTI operations have commenced without adequate consultation with local communities: protests, when forthcoming, have often elicited only the response that the operations planned have the imprimatur of the central government, and that no further dealings with local groups are required, under the terms of agreements entered into. This has apparently led, in some cases, not only to erosion of the efficacy of local, customary institutions which might otherwise have offered a mechanism for management of regenerating forest areas, but also to alienation of whole communities from the central government and its development policies. 3.122. The Government of Indonesia bas-recognized the likelihood of conflict between traditional land users, and development projects. The Directorate of Most Isolated Peoples (DBMT) has a broad mandate to address health, educational technological, economic and religious needs of this group. Historically, DBMTs approach has emphasized relocation of affected communities. There is an issue involved, as to whether this approach, coupled with DBMT's tendency to regard the target groups as indifferenuated and primitive, is appropriate, but this issue goes beyond the scope of this sector review. 3.123. The Ministry of Forestry has introduced the HPH Bina Desa (HPHBD) program, as a means of addressing the forest dwelling community issue. In effect, the HPHBD is intended to create income generating alternatives for forest dependent communities, by causing concessionaires to invest in such programs. 3.124. No systematic review of the success of the HPHBD has been made for this review. Some anecdotal comment collected in the field indicates that the major onus of decision making and negotiation of a specific HPHBD rests upon the conceSsionaire. Where concessionaires are bona-fide and capable, this produces good results, but otherwise, there is relatively little that either GOI, or communities themselves, can do to ensure good performance. In many cases, the interest of concessionaires and communities will be in conflict, and where this is so some process of directing or arbitrating the nature of HPHBD projects would seem to be necessary. Even in cases where concessionaires have been well-intentioned, adverse results have sometimes occurred due to an emphasis by the concessionaire on replacement of extensive agricultural practices with imported intensive technologies (such as wet-rice farming from Java) which have failed under local conditions. 3.125. The legal status of forest communities. Implicit in much of the foregoing commentary is the idea that, where social and economic disruption are likely results from forest operations, some form of prior agreement with affected forest community groups will need to be negotiated: these groups must be positively engaged in the development process, rather than damaged by it. 3.126. When considering options in this area, it is useful to obtain some understanding of the present legal position of such communities in Indonesia, as a basis from which to work towards new agreements. Annex 4 is a review of some recent and historic legislation in Indonesia which relates directly to this issue. 3.127. The basic conclusions which can be drawn from this review are: • The Basic Forestry Law was not intended to invalidate the existing customary land rights of communities. Members of these communities, including the indigenous communities living in Indonesia's forests, have the right under the Agrarian Law as well as the Basic Forestry Law, to continue to manage their forested lands under local resource management regimes and customary law. They have the right, moreover, to have these rights legally recognized, registered, and honored by governmental and private sector actors. If a plaintiff can show that the effect of an implementing regulation is to force into non-existence traditional rights, then this regulation or its implementation in a particular case is in conflict with the law itself. It may possibly be invalidated through review in Administrative Court proceedings. The Basic Forestry Law of 1967 and the Agrarian Law of 1960 are now situated within the context of recent legislation, of equal legal status. This fact alters the legal environment within which indigenous community customary rights to land and resources are viewed and reviewed. Currently, Law Number 10 of 1992 and Law the of 1991 on Spatial Arrangement, recognize community territorial rights, the rights of cultural autonomy, and the priority accorded to historically vulnerable communities. In addition, these laws establish a community right to know what is being planned in its historic area, to review and critique these plans, to participate in a meaningful fashion in planning these activities, and to comment on implementation of these 52 plans. In sum, these recent legislative enactments constitute a new policy landscape in which the rights of indigenous communities are accorded a privileged status within the context of national development. 53 CHAPTER IV THE WOOD PROCESSING INDUSTRIES: POTENTIAL AND ISSUES Introduction 4.1. As pointed out in Chapter I of this review, the forestry sector is an important building block in the economy of Indonesia. Obviously, maintenance and building of a good resource base is fundamental, and issues related to this have been discussed in Chapters ll and ill. In pure value added terms, however, presently most economic activity occurs within the processing sector, and it is likely this will continue to be the case. The fate of the natural forest resource - including many of its national and global environmental values- will in Indonesia depend heavily on the economic fortunes of the processing sector, for the foreseeable future. 4.2. In this chapter, it will be argued that global and regional trends in forest products trade suggest a stable, rather than a dramatically improving (or declining) situation for Indonesia's exports. Whilst the international trading environment in the pci.St for tropical forest products has not been ideal, nor has it been particularly discriminatory: tropical forest products nations seeking a long term and sustainable place in the market need to give priority to review and reform of domestic resource, industry, and trade policies: international initiatives to improve the trading environment have an important, but secondary place. An important linkage between these issues is the emerging n green trend in the international forest products If market: the development of market resistance to products based on unsustainably managed resources. Whatever the eventual outcome of this trend, in the medium term it will be important, in trade and market access terms, for Indonesia to develop sustainable practices, and to demonstrate that it is doing so. 4.3. Indonesia has built a large and powerful forest product sector, on the basis, primarily, of restricting (previously exported) raw material supplies to domestic processing. Information on trends in processing advanced in this Chapter will be used to support some observations relevant to policy in this sector: (i) A large proportion of profit generated in the plywood sector arises from a flow of economic rent to plymills from their corporate ownership of logging concessions, rather than from efficient and competitive value added in processing. (ii) While the imposition of very high export taxes on sawn timber has eliminated the practice of export of large sized sawn material as a means of avoiding the log export ban with minimal value added (one of the objectives of the export tax policy), it has also eliminated smaller sized sawn material - which might equal plywood, in value added terms - from the export market. (iii) The sawnwood export tax policy may also affect the viability of secondary processing (stimulation of which was another goal of the sawn export tax policy) because this sector appears to depend on the existence of a viable, efficient sawmilling sector. Secondary processing development in Indonesia appears to have tapered off, following strong gains early on; a lack of ready access to log supplies may be a contributing factor. Market Developments for Tropical Forest Products 4.4. Although domestic demand for forest products in Indonesia can be expected to continue to grow rapidly, the size and nature of the processing sector - natural forest and plantation based - will remain strongly dependent on developments in the international market for forest products for the foreseeable future. 54 4.5. A great deal has been written on the international market for wood products, and it is not possible to review this work here. All that can be attempted is a listing of findings which seem to find reasonable consensus among analysts, and a discussion of some more specific matters ~elating to Indonesia's case. 4.6. Global consumption. Worldwide, the rate of growth in consumption of wood has been slowing since the 1950s, and most economic models of the forestry sector predict a continuation of this trend. 4.7 Value of trade. In broad terms, the value of forest products entering international trade bas increased more quickly than overall consumption. This seems to be a result more of changes in the composition of trade towards more highly valued products, than of increased volumes of log equivalent being traded. In the particular case of tropical forest products, volumes entering trade have actually declined by about 25 percent from a peak in 1979. Log export bans and related measures have had some role in this, but it is likely that reduced demand and increased competition from temperate sources have also been factors. This trend is not uniform, however: demand for quality hardwood - in raw and processed form - has remained strong, and this has also been the case for some processed products -moldings, beadings, some joinery and household items - not dependent on high quality raw material. 4.8. Regional trend analysis. The standard econometric approach to projecting demand is to identify some major determinants of consumption of wood products which are (to some reasonable extent) forecasteable, and to link consumption patterns for specific products to these parameters, via regression analyses. As part of a study of market prospects for forest products from South East Asia commissioned by the Bank 1, an exercise of this nature bas been attempted, using a global forest products trade model developed by the Centre for International Trade in Forest Products (CINTRAFOR) at Washington State University. The model makes base case2 projections of supply and demand for South East Asia forest inventory and products, and tests sensitivity of projections to some likely development, such as substitution by temperate hardwoods and softwoods in markets currently supplied by tropical hardwoods. There is insufficient space here for a detailed exposition of the results of this modelling exercise: the Bank will be making this study available when drafting is complete. Some of the major results which emerge are: In the base case scenario, the price of logs in all South East Asian and North East Asian markets rises, to the end of the forecast period (2000 AD). Western Malaysia is most affected (a result of depleted log availability on the peninsula, and growing limits on East Malaysian Inventory), and prices in Indonesia are projected to rise by 5% pa over the period. Significantly, in the base case scenario, little or no rise in hardwood log prices in Europe or Japan is projected for the period, due to substitution in those markets by temperate hardwoods and softwoods. The market study assesses temperate hardwoods as being relatively abundant in the medium term, and softwoods also (but over a shorter time frame). These are not open- ended projections: ultimately, supplies for all may become constrained. 1 Jaakko Poyry Consultants/CINTRAFOR (1993) Troptcal Deforestatton m Asta and the Market for Wood, mam report and 9 Annexes prepared for World Bank and liTO. 2 GDP, housing and constructton starts and in some cases income elasticity are projected for each country, and linked to wood use via end use elasticities. 55 Indonesian plywood exports in the base case remain relatively stable for the period, but destinations change significantly, away from Japan, and towards Korea and China. There is only modest price gain for hardwood ply projected for the major markets: Malaysia is the exception, due to declining domestic supplies combined with import bans. Sawnwood export from Malaysia in the base case is projected to decline (from 6 million cum p.a. to around 4 million cum p.a. by 2000 AD); Indonesia's production and consumption remain more or less in balance (constrained by current policies); sawnwood prices rise in all markets. 4.9. Trade and sustainability. The pattern of forestry operations in many tropical countries has frequently followed a boom-and-bust cycle: an accelerating exploitation of an originally abundant resource to well beyond the point of sustainable output, followed by a rapid decline as resources become scarcer and more costly to extract, to the point (as is presently occurring in both Thailand and the Philippines) where net importation of forest products is in prospect. Often, this pattern has been attributed to the nature of the trading relationship between developing country forest exporters, and more developed importers of forest output: richer countries have been accused of manipulating prices of tropical forest products downwards and discouraging development of value-added processing in the forest rich countries, through erection ofhigh tariff and non-tariff barriers. 4.10. While there may be examples from the past where this occurred, there is little evidence to suggest that it is a significant factor now. Vincentl has compiled data which show that in 1989, developing countries exported only 11 percent of their roundwood harvest in raw form (more than double this amount was exported in processed form), and that much of this export went to other developing economies. Vincent acknowledges that tropical countries have suffered some harm from trade barriers on processed imports in developed country markets, but cites studies which show this effect has been fairly minor. 4.11. So far as the question of low prices for traded tropical forest products is concerned, it can be shown that, broadly speaking, tropical forest products do no better or worse in this respect than their temperate counterparts. They are, for the most part, commodity grade products sold in bulk, and in this market real price declines have been the rule rather than the exception in recent decades: diverse sources of competition and no shortage of the wide range of wood resources which can be used in such products suggests that this will continue to be the case. · 4.12. Most studies of the tropical timber situation in recent years agree that sustainability of the tropical timber resource has relatively little to do with the nature of international trade, and much to do with domestic policies (and their implementation) applied in forest owning countries. Within the forestry sector itself, policies which enforce domestic processing by restricting raw material exports, and which otherwise force raw material prices to be low, will not necessarilly promote sustainability and, if they create artificially low raw material prices, are in fact likely to contribute to forest decline. Ex-sectoral policies - especially those which subsidize other forms of landuse on forested areas - will also contribute to forest decline, and macroeconomic policies - trade and non-trade related - can also have this effect. 4.13. It can be concluded that Indonesia, in common with other forest product trading nations, will face strong competition in the international market. While continued opportunities will exist in trade, there is no apparent boom in demand for the products Indonesia exports in the offing, and domestic policies promoting efficiency and competitiveness will be fundamental to success in this sector. 3 Vincent, J.R., 1992, "The Tropical Timber Trade and Sustainable Development" Science, Vol256, 19 June. 56 4.14. The environmental factor in trade: the Japanese example. One essential ingredient in development of a successful long term forest products industry, obviously, is availability of good quality raw material over the long term. But, in the case of sustainability of forests, the environmental movement has added a more immediate and urgent political dimension to this matter: whatever the views of tropical forest product exporting countries, a cost of remaining effectively in this trade is increasingly going to be the ability to manage natural forests sustainably, and be seen to be doing so. In recent months. awareness of this issue in Indonesia bas escalated sharply, as a perusal of recent articles in the press will demonstrate. It seems the case that even consumer countries which do not enact blanket bans on tropical forest product imports are increasingly moving towards requirement of some form of certification that products being sold in their markets have come from properly managed forests: so-called "green labelling" is therefore a high profile issue in Indonesia at present. This is timely, because political positions on the matter have not yet hardened: there is still an opportunity for certification measures to be designed and promoted, as a preferred alternative to wholesale bans on importation of tropical forest products in major consuming regions. 4.15. Some insight into the practical implications of this issue can be obtained though observations of recent developments in Japan. Public concern in Japan over tropical hardwood resources rose significantly in 1992, and various actions have been taken or are being planned in both public and private sectors. These developments may have long-term demand implications for Indonesian forestry and forest industries, because Japan is by far the largest consumer of tropical hardwood plywood in the world. Japanese plywood producers use tropical hardwood logs imported primarily from Malaysia and Papua New Guinea (PNG). In addition, Japan imports a large volume of tropical hardwood plywood, over 95% of which comes from Indonesia; imports now account for one third of plywood consumption in Japan. In 1990, Japan consumed roughly 14.8 million cubic meters (roundwood equivalent) oftropical hardwood in the form of plywood. In addition, Japan consumed roughly 4.3 million cubic meters (roundwood equivalent) in the form of sawnwood. Including other minor products, Japan consumed about 20 million cubic meters of tropical hardwood in roundwood equivalent in 1990. 4.16. A particular target of public concern is the so-called "kon-pane", 12mm-thick plywood which is used for concrete forming during construction. This product forms a major part of Indonesia's exports to Japan (see Table 4.5). It is re-usable, but after being re-used several times iris discarded. Concrete panel bas become a symbol of "wasteful" use of valuable nonrenewable tropical hardwood, along with disposable chopsticks. 4.17. Japan's Construction Ministry recently announced a plan to encourage use of softwoods, which are renewable and grow faster than tropical hardwoods, in publicly funded construction projects4 • The plan includes: (a) an urgent review of construction standards in order to talc~ account fully of the substitution potential of softwoods (with particular attention to plywood); (b) nation-wide distribution of a construction manual incorporating the results of that review; (c) selection of publicly funded construction projects all over Japan as "model projects" for implementing maximum use of so~ood products in place of traditionally used hardwood products; and (d) issuing of purchase orders for such softwood products to be used for the selected projects before the end of the current fiscal year (March 1993). 4.18. This initiative was preceded by similar moves by local entities. In October 1991, the Tokyo metropolitan government announced a plan to reduce the use of tropical hardwood products in its construction projects. Several other major local entities also announced plans to study ways to minimize the use oftropical hardwood concrete panels in publicly-funded construction projects: e.g., Osaka City (January 1992), Osaka Prefecture (February 1992) and Kobe City (August 1992). Now that the central government bas moved on this issue, many more local entities are likely to follow. • NIKKEI Commodity Information Service, October 12, 1992. 57 4.19. In the private sector, in February 1992, the Building and Construction Industry Association announced a target of 35-percent reduction in the use of concrete panels made wholly of tropical hardwood over the next five years. In making this announcement, the Association gave three reasons: (1) uncertain sustainability of future supply of tropical hardwood concrete panels; (2) the environmental wastefulness of using tropical hardwood as concrete panels; and (3) in view of rising labor costs in construction, the need to find less labor-intensive ways for concrete forming than the current procedures requiring tropical hardwood concrete panels. 4.20. The likely outcome of these initiatives needs to be kept in some perspective. Hardwood ply is still preferred in technical terms because it is stronger and more rigid. Also, at the present time softwood panels would cost 10% - 30% more to produce in Japan, because: (1) the average recovery rate in softwood plywood manufacturing is less than 50%, as compared with close to 70% for hardwood plywood; and (2) production of softwood plywood would require a substantial fresh investment in new machinery while most existing plywood machinery in Japan, which is geared to produce hardwood plywood, has been totally depreciated on the books. Reportedly, in 1992 production of plywood using New Zealand radiata pine as core-ply has increased in Japan, and investments in facilities to produce such mixed-species plywood have also increased. The investments in new equipment for producing mixed species plywood were triggered by the recent rises in the prices of tropical hardwood logs (Nihon Keizai Shimbun, October 17, 1992). This may go further: as capacity to produce plywood with a softwood cpre increases, in Japan, the likelihood that Japan will impose a ban or restrictions on imports of 100% tropical hardwood plywood increases. Such bans could be justified on environmental grounds (presumably, however, these will remain contestable under the General Agreement on Tariffs and Trade), albeit that they would coincidentally benefit local plywood producers. Thus, an important issue for Indonesia's plantation policy arises: the extent to which emphasis should be given to producing ply grade material from plantations in Indonesia. 4.21. It may also be that, driven in part by environmental concern, technologies may develop to by- pass the use of plywood in construction. A major construction company has recently developed a new method of concrete forming, called the "pre-cast column" procedure, which uses pre-cast concrete columns instead of plywood forms. The pre-cast column made of concrete has been approved by the Japan Architectural Center (JAC). An approval by JAC is a prerequisite for an approval by the Minister of Construction. To date, the scope for practical application of this technology is quite limited, because it is economically applicable only in situations involving considerable uniformity in the size and strength requirements of such columns (the concrete pre-cast columns must be mass-produced in order to contain' costs of production). Nevertheless, this, and the possibility discussed in para 4.20, suggest that Indonesia may have relatively little time to negotiate acceptance of its product on the basis of sustainability, and, by extension, to implement serious m~ures in the field to achieve that sustainability. The Indonesian Forest Industries Sector: Recent Issues 4.22. GOI objectives. Forestry is not identified as a separate sector in the Repelitas, and in Repelita V, forestry-related programs are spread over seven sectors. However, the Ministry of Forestry (MOFr) had the following goals for the processing sector, based on a document prepared by MOFr for Repelita Vat the end of 1986: (a) to reach the following production levels for the major products, by the year 1999: sawn timber 17.2 million m3 plywood 11.9 million m3 wood-based panels 1.2 million m3 pulp and paper l.6 million m3 58 (b) to reach the above targets through optimal utilization of raw materials, especially by increasing the recovery rates for the entire wood processing sector (i.e. to 60% during Repelita IV, 70% during Repelita V and 80% during Repelita VI); (c) to create employment of 9.3 million in the industrial sector as a whole, with wood processing playing a significant role; (d) to equalize the distribution of development and income, with wood processing playing major roles in developing structurally underprivileged areas in the outer islands: (e) to promote small scale industries, with some forest products included specifically for this purpose under Repelita IV; and (f) to increase export volume (and earnings) from the wood processing sector, with the following specific targets: Repelita VRepelita VI sawn timber 4.2 mill.m 34.8 mill.m 3 plywood 5.8 mill.m37.5 mill.m3 4.23. Institutional framework. Since 1986, wood industry policies have been coordinated by the Coordination Team for Forest Industries or TKIHH, which consists of representatives from MOFr, MOl and the Ministry of Trade. The ministries take turns acting as the secretariat for its periodical meetings. This unit also provides inputs into the Repelita. 4.24. Recent policy actions. With the above objectives forming a basis, GOI undertook a series of policy actions, designed mostly to shift resources in the wood processing sector to higher value added activities. In 1985, GOI instituted a total ban on log exports. It also raised requirements for concessions to link with processing units. Starting 1989, in the face of an already expanded output capacity and more stringent restrictions on forest resource exploitation, GOI discouraged establishment of new plywood mills and sawmills, except in the less-exploited areas oflrian Jaya and East Timor. It also banned establishment of new facilities for processing of rattan, except in the outer islands. Also in 1989, GOI placed prohibitively high export tariffs on sawnwood. Finally, in 1992, GOI replaced the log export ban also with prohibitively high export tariffs. 0.11 the macroeconomic front, measures were taken to create an export-oriented incentive framework: large devaluations of the Rupiah in 1983 and 1986 helped to create an export-industry oriented incentive framework. The effects of these policy measures will be examined later in this chapter. 4.25. Investment. Trends in investment for the wood processing sector as a whole provide some useful background in analyzing each of the processing industries. As can be seen from Table 4.1, new investment in wood processing bas bad a very small share in total investment, both for domestic and foreign investment, especially after 1988, and the share appears to be decreasing. Both domestic and foreign investment amounts in wood processing fell sharply in 1991, and the downturn will most likely continue in 1992, judging from the January-June data. The data given are based on approvals, and the actual investment amounts would be lower. Domestic investment slowed down in general, falling from Rp. 59.9 trillion in 1990 to Rp. 41.1 trillion in 1991 and then to Rp.18.0 trillion for the first seven months of 1992. In the wood based industries, the investment policies of BKPM 5 seem to have bad a specific role in the investment slowdown: (a) restrictions on investment in plywood, sawmilling and rattan processing since 1989 mentioned above; and 5 The Investment Coordinatmg Board. It monitors and approves applications for investment, both from domestiC and foreign mvestors. 59 (b) a new requirement for prospective investors in secondary wood processing to present BKPM evidence of wood supply when applying for approval (this exclusion does not appear on GOI's Negauve Investment list proposed in Presidential Decree 23/1991). 4.26. Despite GOI's stated policy to promote wood-based industries, there are few specific instruments to promote investment in these industries, beyond the restrictions on raw and sawn exports. In the pulp and paper industry, holders of HTI over 1,000 ha are partially exempted from import tariffs for capital goods and raw materials needed to produce pulp and paper. There was also initially some concessional lending to investors in plywood manufacturing. Table 4 I· INVESTMENTS IN WOOD PROCESSING BY YEAR 1988- 1991 ' 1988 1989 1990 1991 1992 (Jan.-June) Domestic investments no. of approvals 149 120 116 55 8 amount of approvals 1,459.0 743.9 2,179.3 1,569 0 439.3 (Rp. billion) share m total approved 10.2 3.8 3.6 38 2.4 (amount(%) Foreign investments no. of approvals 13 25 30 13 4 amount of approvals 76.9 105.9 217.6 62.2 21.2 (US$ million) share in total approved 1.7 2.2 2.5 0.7 0.5 amount(%) Source: BKPM (National Investment Coordination Board). The Plvwood Industry 4.27. Growth of the industry. Indonesia was a late starter in production of plywood, even among the countries in Asia and the Pacific. Investment in plywood mills started to expand dramatically in Indonesia during the late 1970s; between 1975 and 1979 plywood production increased six-fold (Table 4.2). Between 1979 and 1984 (the year before the total log export ban) production again increased six-fold, even though this period coincided with a major world recession. For comparison, plywood production in the Philippines dropped from 553,000 cu.m. in 1980 to 329,000 cu.m. in 1982, before recovering to 504,000 cu.m. in 1984. In 1991, plywood production in Indonesia reached 9.1 million cu.m., which is more than 80 percent higher than in 1985. 4.28. With such rapid expansion, Indonesia became the largest producer of plywood in Asia, and the largest in the world among those using tropical hardwood for inputs. As can be seen in Table 4.3 below, Indonesia was a relatively small producer in 1980, accounting for only 7 percent of total production from Asia. At the time, Japan and Korea were the dominant producers, with 55.3 and 10.9 percent of total production, respectively. The picture changed dramatically over the next ten years: Indonesia emerged as the dominant plywood producer in the region, accounting for 43.7 percent of the region's output. Production by Japan and Korea has declined not only in relative "terms within the region, but also in terms of absolute amounts. 60 Table 4.2: PRODUCTION OF PLYWOOD BY YEAR, 1973 - 1991 Year Number of Mills Production (m3) 1973 2 19,000 1974 5 24,000 1975 8 10,700 1976 14 214,000 1977 17 279,000 1978 19 424,000 1979 21 624,000 1980 29 1,011,000 1981 40 1,552,000 1982 61 2,140,000 1983 79 2,943,000 1984 95 3,820,000 1985 101 4,983,000 1986 NA 5,302,000 1987 NA 6,400,000 1988 NA 6,560,000 1989 NA NA 1990 NA NA 1991\a 118 9,063,735 Source: - APKINDO. - FAO/GOI Forestry Studies UTF/INS/065/INS. - Project Data Base. Table 4.3: ESTIMATED PRODUCTION OF PLYWOOD IN ASEAN COUNTRIES (in thousand cum) Share Country in Region 1980 Share 1990 in Region Indonesia 1,011 7.0% 9,250 43.7% Japan 8,000 55.3% 6,417 30.3% Korea 1,575 10.9% ~.124 5.3% Malaysia 601 4.2% 1,090 5.2% Philippines 553 3.8% . 397 1.9% Singapore 579 4.0% 399 1.9% Other Asia 2,140 14.8% 2,485 11.7% Total 14.459 100.0% 21,162 100.0% Source: FAO Forest Products Yearbook; 1990. 4.29. Distribution of mills:· By Regions and Ownership. Much of the new investment in plywood mills took place in the outer islands, particularly in Kalimantan. By fisca11983/84 Kalimantan was producing 51% of the total volume of plywood manufactured in Indonesia, and production in Kalimantan more than 61 doubled during the next five years, to account for 57% of the national total in fiscal 1988/89. Production increased only marginally in Java and Bali. 4.30. There are now 118 plywood mills in Indonesia (Table 4.4). This is a nominal figure, as some large production facilities belonging to nominally separate companies operate under one roof and the same management, and are counted as separate mills (e.g. 12 lines belonging to five nominally different firms, all in one large plant in Maluku). About half of these are concentrated in Kalimantan, with East Kalimantan alone accounting for 28 on a nominal basis. Due to lack of the wood species traditionaiJy preferred for plywood production, there is only one plywood mill in Irian Jaya, which was recently established. However, with resource constraints becoming apparent elsewhere in Indonesia, this situation may soon change rapidly. Table 4 4· PLYWOOD PRODUCTION CAPACITY AND ACTUAL OUTPUT BY PROVINCE, 1992 PROVINCE Number of Establish- Installed Capac1ty . Share in Actual Producuon Share 1n Capac1ty UtilizatiOn Av. Capa. per Estab. Share in Total ment (cum) Total (cum) Total (cum) Capacity D.I. Aceh 2 203,400 2.4% 179,835 2.2% 88.4% 101,700 2.4% North Sumatra 5 467,950 5.6% 448,290 5.5% 95.8% 93,590 5.6% West Sumatra I 60,000 0.7% 41,278 0.5% 68.8% 60,000 0.7% R.Jau 12 785,736 9.4% 809,770 99% 103.1%. 65,478 9.4% Jambi 9 500,000 6.0% 484,700 5.9% 96.9% 55,556 6.0% Soulh Sumatra 4 262,572 3.1% 247,105 3.0% 94.1% 65,643 3.1$ Lampung I 83,700 1.0% 66,396 0.8% 79.3% 83,700 1.0% West Java I 71,428 0.9% 58,535 0.7% 81.9% 71,428 0.9% Central Java I 432,000 5.2$ 387,748 4.7% 89.8% 432,000 5.2% East Java 3 435,700 5.2% 413,440 5.1% 94.9% 145,233 5.2% West Kalimantan 14 1,041,962 12.4% 1,142,619 14.0% 109.7% 74,426 12.4% Central Kalimantan 7 924,695 11.0% 905,531 11.1% 97.9% 132,099 11.0% Soulh Kalimantan 14 456,450 5.5% 438,427 5.4% 96.1% 32,604 5.5% East Kalimantan 28 1,159,523 21.0% 1,720,102 21.0% 97.8% 62,840 21.0% Soulh Sulawesi 2 85,472 1.0% 69,912 0.9% 81.8% 42,736 1.0% Maluku 13 710,600 8.5% 694,405 8.5% 97.7% 54,662 8.5% Irian Jaya I 90,000 1.1% 63,901 0.8% 71.0% 90,000 1.1% Total 118 8,371,188 100.0% 8,172,000 100.0% 97.6% 70,942 100.0% Source: Ministry of Industry. 4.31. Most of the plywood mills are owned by Indonesian firms, except for one state-owned mill in East Kalimantan and another in Java. There are about 10 mills based on joint venture arrangements. 4.32. Size of the mills. With greater availability of labor and better transport infrastructure, installed capacities for mills in Java are much larger than those in other regions (roughly twice the national average), although there are only five of them. With an average (nominal) installed capacity of about 71,000 cu.m. per year, plywood mills in Indonesia tend to be much larger than those in the Philippines, where the average was 13,300 cu.m. in 1984. 4.33. Markets. Most plywood produced has been directed to the international market {Table 4.5): less than 20% of production has been sold domestically. Producers have an incentive to sell to export, because this can be done in large shipments, and prices received tend to be better. It bas been reported in a number of studies that plywood sold domestically is largely material that would not be acceptable on the export market. 62 Table 4.5: EXPORT OF PLYWOOD BY DESTINATION, 1991 Market VolumeMJ Arnt.CNF.USS Share (of Unit Price total amount) (USS/mJ) USA/Canada 662,308 254,189,839 11.1% 383.8 UK/lreland 191,559 75,338,129 3.3% 393.3 Continental Europe 428,142 165,150,054 7.2% 385.7 China 1,149,198 434,610,052 18.5% 369.5 Taiwan 233,324 73,881,507 3.2% 316.6 Singapore 63,329 18,292,558 0.8% 288.8 Middle East 307,325 103,993,504 4.5% 338.4 Japan 1,975,363 685,295,674 29.8% 346.9 E.Aaia (excluding Japan) 999,860 337,986,860 14.7% 338.0 Hong Kong 286,433 91,208,681 4.0% 318.4 Others 169,613 66,286,921 2.9% 390.8 Total 6,464,696 2,296,224,179 100.0% 355.2 Souree: APKJNDO. 4.34. Japan is the largest buyer oflndonesian plywood (Table 4.5). Originally, most of this volume went into concrete-forming panels ("kon-pane") but, according to the forthcoming World Bank-ITTO consultants study of trade in forest products from South East Asia (op cit, see pg. 56) this usage accounted for slightly less than half of total Indonesian plywood exports in 1991. Penetration of the Japanese plywood market, and those of Korean and Taiwan, has been spearheaded by the industry association, APKINDO, which is able to exercise considerable influence in the sector, via compulsory membership, control over export licensing, and control over marketing outlets in Japan (NIPINDO). Some processors claim that AP.KINDO has obliged processors to sell part of their output at prices as low as $230/cu.m., in pursuit of market share: no substantiation of this was possible, although it is known that in January 1990, APKINDO did require a quota of output of 15% (based on previous year's production) to be sold through its agency in Japan, presumably in pursuit of market share there. It is possible that at least part of the recent rapid expansion in output of decorative ply in Indonesia could be related to this factor: output of this product rose from 25000 cum. in 1989/90, to 0.5 million cu.m. a year later. It appears that, originally, producers were allowed to include decorative plywood as part of their APKINDO quota, but were exempted from marketing it through APKINDO. It will be a relatively simple matter to evaluate whether there is substance to this theory soon, because apparently this exemption has now been revoked: significant declines in decorative ply output would signal that it bas been a factor. 4.35. Capacity utilization rates. Although capacity utilization was low in the plywood industry at its early stages, which was quite natural with the rapid expansion in installed capacity, it has been rising steadily since 1979 (Table 4.6). The rate improved from 35 percent in 1979 to 81 percent in 1985. 4.36. With the ban on establishing new plywood mills in' areas other than Irian Jaya and East Timor in 1989, expansion of installed capacity has virtually stopped, pushfng up the capacity utilization rate further: it has therefore approached officially recorded maximum levels {97.6% in fiscal 1991/92, see Table 4.4, and Table 4.7 below), and according to some estimates of actual production, may have exceeded these and now be close to the technical maximum. Targets prepared by MOl to feed into Repelita VI suggest that GOI sees new investments in plywood mills taking place slowly (about 200,000 cu.m. per year) during the coming years, while continuing to operate virtually at full capacity (Table 4. 7). 63 Table 4.6: DEVELOPMENT OF CAPACITY UTILIZATION (1973- 1985) Installed Output Actual Capacity YEAR Capacity Production Utilization (tons) (tons) 1973 28,000 19,000 67.9% 1974 103,000 24,000 23.3% 1975 305,000 107,000 35.1% 1976 405,000 214,000 52.8% 1977 535,000 279,000 52.1% 1978 799,000 424,000 53.1% 1979 1,809,000 624,000 34.5% 1980 1,949,000 1,011,000 51.9% 1981 2,60i,500 1,522,000 58.5% 1982 3,292,400 2,140,000 65.0% 1983 4,477,100 2,943,265 65.7% 1984 5,327,600 3,820,000 71.7% 1985 6,172,140 4,983,000 80.7% Source: Atlanta (op cit, see pg.22). 4.37. Supply of raw materials. All plywood mills have either their own concessions, or are supplied by concessions with close ownership ties to their mills. However, the majority of mills also buy some logs in the open market: in 1987, according to Atlanta (op cit, see pg. 22), about 10 percent of total log requirements for plywood production were purchased in the open market, and anecdotal evidence suggests this proportion may now have increased. Given the dominance of major plywood operations, especially in some regions, it is difficult to assess the impact of oligopsony or monopsony in price formation of logs sold in the market. Table 4.7: PRODUCTION, INSTALLED CAPACITY AND DEMAND FOR PLYWOOD, BY FISCAL YEAR - ACTUAL AND PLANNED (in thousand m3) 87/88 88/89 89/90 90/91 91/92 (growth 92/93 93/94 94/95 95196 87/88-91/92) -ACTUAL -PLANNED- Installed capacny 7,067 7,574 7,820 8,372 8,372 18.5% 8,500 8,750 9,000 9,200 Acrual production 6,160 6,940 7,076 1,558 8,172 32.7% 8,200 8,500 8,700 8,900 Capacay Utilizauon 87.2% 91.6% 90.5% 90.3% 97.6% 96.5% 97.1% 96.7% 96.7 % Domesucally Solid 1,160 1,200 1.250 1,500 1,550 33.6% 1,600 1,650 1,700 1,750 (share 1n total dem.) 18.8% 17.3% 17.7% 19.8% 19.0% 19.5% 19 4% 19.5% 19.7 % Exported 5,000 5,140 5,826 6,058 6,622 32.4% 6,600 6,850 7,000 7,150 (share in total dem) 81.2% 82.7% 82.3% 80.2% 81.0% 80.5% 80.6% 80.5% 80.3 % - Source: Ministry of Industry. 64 4.38. Recovery Rates. The average recovery rate for the plywood industry in Indonesia was estimated to be 54 percent in 1987 (Atlanta, op cit, see pg. 22), which is high for a developing country (e.g. compared to SO percent in the Philippines in 1980). APKINDO estimates a figure of 58 percent. This may be explained by the good size and shape of the logs used in plywood production and the relatively new equipment used (over 60 percent of the mills were constructed after 1980). The Atlanta study also conducted some field investigation on a sampling basis, and discovered that, while the average recovery rate for the 12 sampled mills was 53.2 percent, there was considerable variance among the mills (ranging from 76.7 to 41.0 percent), and that the recovery rate for each mill was affected by the raw material used, the condition of equipment, and the level of training for the employees. Wood recovery bas been increasing slightly in recent years, i.e. by 3.53 percent per annum during 1986-87 according to an estimate by Constantino (in FAO Studies, op cit, see pg.35). 4.39. Total Factor Productivity. Total factor productivity has increased by 1.6 percent per annum over the period 1975-87 (FAO, op cit, see pg. 35), which is in sharp contrast with the sawmilling industry where it declined over the same period (see para 4.56 below). The relative efficiency of the plywood industry has been attributed to two factors: (a) the relatively new vintage of the equipment and technologies used; and (b) the possible prevention of inefficient producers from entering the market due to a decline in international prices in the 1980s. 4.40. Production Costs. There is very little information on actual production costs for plywood in Indonesia. The two published studies which exist on this topic, one done in 1987 (Atlanta) and the other in 1989 (FAO/GOI), have drawn similar conclusions on the structure of production costs for plywood in Indonesia, that 50- 60 percent oftotal production cost can be attributed to raw material (log) costs. However, these estimates assume delivered log prices of $70 per cum: in the case where logs come from concessions integrated with mill operations, cost of logs will be less (see Table 5.1 and surrounding discussion). The World Bank-liTO Study (op cit, see pg. 54) will show an estimate that manufacturing costs for plywood in Indonesia, excluding log costs and net of margins, are about $145 per cum. A delivered log cost of$62/cum round (see para 5 .18) is equivalent to $114 log cost per cum of processed output, on the basis of recovery of 54% (see para 4.38 above). On this basis, log cost would amount to 44% of total costs. 4.41. If delivered log costs for 1985 of $40 per cum (an estimate based on extraction costs in that year, and the lower DR & nrn fees which applied), and $62 per cum for 1991 are used, the overall production costs shown in Table 4.8 result. Had ply mills in 1991 actually had to pay around $90 per cum Table 4.8: ESTIMATED PRODUCTION COSTS FOR PLYWOOD IN INDONESIA, 1986 AND 1991 1986 1! 1991 ~ Cost Item US$/m3 Percentage US$/m3 Percentage Logs 74.6 44% 115 44% Auxiliaries 40.0 24% 49 19% MainteniUlce 3.0 2% Labor 21.0 12% - ~ 13% Deprec1ation 21.0 12% 25 10% Other 11.0 6% ...12 15% Total Production Costs 170.0 100.0% 263 100.0% Sources: 1! Atlanta (op cit, see pg.22) but with an at-million pnce of $40 pr cum substituted. lh World Bank- mo (op c1t, see pg.54) but with log prices and recovery rates as estimated by rev1ew mission. 65 for logs at mill, which is given as the market rate (see paras 5.19 to 5.21), then production costs (net of margins) would have been $314 per cum. Prices given in the FAO Yearbook for Indonesian plywood have been static at around $320 per cum (although the review mission received an estimate nearer $355/cum). On these figures, producers would have been under considerable pressure, especially if there has been pressure to sell below these prices (see para 4.34). 4.42. Efficiency ::md competitiveness issues in plywood manufacturing. The above analysis suggests that, if plywood manufacturers in Indonesia were compelled to pay prices nearer international norms for logs, efficiency of log harvesting and utilization would rise. In Japan, where raw material for plywood manufacture is expensive, recovery from raw log to processed form is 68 percent by volume. In Indonesia, one major company is presently achieving a recovery rate of 60 percent, and it is perhaps significant that this company has no connection to a concession operation, and is compelled to pu~chase its log supplies on the open market. 4.43. In a situation where high-grading of the raw material resource is possible, as seems at least in some cases to apply in Indonesia, and where rent capture for that resource by the industry is high, as also seems to be the case (see Chapter V), it would be expected that the processing sector acts as a proxy for log exporting: the motivation in processing becomes raw material rent capture, rather than profitability and efficiency in processing per se. The calculations given in para 4.41 suggest this may be the case. 4.44. The Government of Indonesia, and the plywood industry, have recognized that the limits to grov.rth of the sector are being approached, and there have been recent moves on the part of both to discourage installation of additional plywood manufacturing capacity in Indonesia. The main thrust of industry policy in this sector since the early 1980s has been the establishment of a large domestic plywood manufacturing base, and this has been achieved. Presumably, the objectives now must become consolidation, efficiency, and competiti veoess. 4.45. As implied in paras 4.15 to 4.21 above, a stagnation in demand for concrete panelling -a major user of tropical plywood- is possible in Japan. The industry may need now to look at diversifying. One direction which may need to be pursued is further processing of tropical plywood into fancy or decorative grades. This is less a technical matter than one of developing the necessary marketing expertise to produce on a made-to- order basis, which may require establishment of closer relations with buyers than has b~n needed in the case of commodity grade plywood. 4.46. Another possibility, which links closely to the economics of plantation examined in paras 3.85 to 3.92, is the development of either (or both) commodity grade and high grade plantation plywood material, so that potential environmental barriers to marketing can be overcome. 4.47. These are possibilities for the private sector to explore. The private sector would be more encouraged to do so if the operation of the Jog market is allowed to adjust to the realities of increasing scarcity, and a new awareness of the other values of the forest. The specific log pricing issue is examined in Chapter V. If the Government chooses to use price to ration the raw material resource (on the basis of sustainable output) among users in Indonesia, it can choose from two basic approaches: (i) the linkage between concessions and plywood mills could be nullified, by offering all concession renewals for auction, or arranging for contract logging and log markets to replace the concession system altogether. This would be a radical departure from current GOI policy, which is to foster linkage between logging and processing (see para 3.38); (ii) the less radical option would be to retain present concession arrangements, but to promote efficiency by setting prices fo"r the raw material in a manner that emulates the working of a stumpage market as closely as possible, so that only efficient users are encouraged to remain 66 in processing. Or, if price calculation per se proves problematical, then taxes on log production could be employed, at least until a pricing methodology can be implemented. 4.48. Such a ~ove would promote technical and efficiency developments within the plywood manufacturing sector, and may stimulate some reallocation of log volumes amongst the various processing options in the country. It would need to be supplemented by deregulation in trade and foreign investment. In trade, export licensing - however administered - should not be used as a means of directing production into certain commodities or markets. It is most unlikely, when looking at the overall trading picture for Indonesian forest products, that any significant long term monopoly advantages will result from gaining market share in present markets: the options major consumers have, in terms of competing suppliers and substitute products, are too broad for such a strategy to succeed. In general it is preferable that individual producers should decide upon the value of market share and the strategies to apply in marketing output especially in the wood products sector, where niche marketing and specific linkage to traders in major markets is important. Also, it is the case that Indonesia bas implemented a program to encourage greater foreign participation in industry. It will be particularly important for this to occur in forest processing if, as seems likely, the future of the industry lies in higher value added and more efficient use of the raw material resource, in an internationally competitive context. It does occur, it is certain that individual foreign participants will have their own ideas on market strategy. The Sawnwood Industry 4.49. Output, Demand, Exports. Since sawnwood is produced by a large number of mills, including many small and medium sized ones, its actual production is extremely difficult to estimate. According to ISA statistics, outputofsawnwood increas'ed from 7.8 million cu.m. in 1984 to 11.1 million cu.m. in 1989, a rate of 7.3 percent per annum (see table 4.9 below). Roughly a third of the output was exported during these years. Table 4.9: OliTPliT AND EXPORTS OF SWANWOOD BY YEAR, 1984- 1991 Year Output ('000 m3) Exports ('000 m3) 1984 7,750 2,318 1985 8,108 2,152 1986 8,649 2,419 1987 9,331 2,772 1988 10,515 3,540 1989 11,100 3,488 1990 7,796 n.a. 1991 8,480 n.a. Source: ISA. 4.50. However, the high tariffs imposed on sawnwood in October 1989 changed the course of development for the industry. Actual production dropped by 30 percent between 1989 and 1990, from 11.1 million cu.m. to 7.8 million cu.m., and export earnings went from US$665 million to US$ 100 million. The effect on installed capacity is much less clear; according to Ministry of Industry statistics it has stayed constant since fiscal 1989/90 at about 15 million cu.m. per year (see Table 4.10). It may be that manufacturers have for the time being only reduced their output and not yet gone out of sawmilling. This can be expected to cause unit production costs to rise, and to squeeze margins from sawmilling. Many of the less efficient mills, especially the smaller ones not linked to HPHs (see para 4.51 below), will soon exit from the market, or may already have done so, according to anecdotal evidence. For the present, official statistics record the existence of about 4,000 sawmills throughout Indonesia. 67 Table 4.10: SAWNWOOD PRODUCTION CAPACITY AND ACTUAL OUTPUT BY PROVINCE, 1992 Numberoi lns!alled Actual Capac1ty Average Cap. Share 10 Province Es14blishments Capacity Production Utilizauon per Est. Total (cum) (cum) (cum) Capacity D.I. Aceh 200 497,445 313,012 62.9% 2,487 3.3% North Sumatra 229 832,950 565,737 67.9% 3,637 5.6% West Sumatra 54 638,260 493,575 77.3% 11,820 4.3% Riau 241 991,424 699,375 70.5% 4,114 6.6% Jambi 89 1,024,558 826,406 80.7% 11,512 6.8% Bengltulu 3 122,800 91,966 74.9% 40,933 0.8% South Sumatra 808 1,756,625 1,136,544 64.7% 2,174 11.7% Lampung 82 250,900 162,441 64.7% 3,060 1.7% DKI Jakarta 47 120,820 94,952 78.6% 2,571 0.8% West Java ISS 156,418 116,881 74.7% 1.009 1.0% Central Java 546 1,129,129 844,872 74.8% 2.068 7.5% D.l. Yogyak:arta 34 11,595 9,931 85.6% 341 0.1% East Java 554 770,850 591,344 76.7% 1,391 5.1% West Kalimanl4n 81 1,076,300 754,069 70.1% 13.288 7.2% Central Kalimantan 161 1,142,211 741,223 64.9% 7,094 7.6% South Kalimanl4n 202 1,155,496 733,882 63.5% 5,720 7.7% East Kaliman1an 224 1,755,660 1,240,207 70.6% 7,838 11.7% North Sulawesi 167 83,097 55,526 66.8% ·498 0.6% Central Sulawesi 241 576,885 386,311 67.0% 2,394 3.8% South-East Sulawesi 52 179,608 117,224 65.3% 3,454 1.2% South Sulawesi 98 296,220 195,555 66.0% 3,023 2.0% West Nusa Te~ggara 16 38,629 26,290 68.1% 2,414 0.3% Maluk:u 102 385,700 285,674 74.1% 3,781 2.6% Irian Jaya 4 10,420 9,003 86.4% 2,605 0.1% To141 4,386 14,993,580 10,482,997 69.9% 3,419 100.0% Source: Ministry of Industry. 4.51. HPH vs. non-HPH. According to Hardie 6 , of the 4,000 or so sawmills in Indonesia (of all sizes), those linked directly with HPHs account for only about 10 percent in number, but hav.e 65 percent of the total production capacity for the industry (most with installed capacity of more than 12,000 cu.m). The majority of HPH mills are integrated with plywood operations, and in many cases also with blackboard mills. Kalimantan and Sumatra account for about 52 and 32 percent of the total installed capacity for these mills. Smaller non-HPH mills have 80 percent of their capacity in Kalimantan and Sumatra. Their output is mainly directed to the domestic market, and this was so even before the introduction of high tariffs on sawnwood. With the probable fall in domestic sawnwood prices after 1989, these non-HPH mills will be hard pressed to survive. Note that the proportion of capacity located in Kalimantan and Sumatra are much higher in these figures than in the more recent MOl estimate provided in Table 4.10 above; although it is reasonable to assume that much of the expansion in sawmilling capacity took place in regions other than Kalimantan and Sumatra between 1987 and 1992, the difference does seem too large to be realized in only five years, which may suggest data accuracy problems. 4.52. Capacity utilization rate. According to Ministry of Industry (MOT) statistics, the capacity utilization rate for sawmills as a whole was 70 percent in 1992 (table 4.1 0). This is not consistent with Hardie's findings, that the rate is about 60 percent for the larger HPH mills, and even lower for the smaller 6 Hardie, D (1989) "Sawmilling and Woodworking: Prospects for Development" in FAO (cited pg.35). 68 non-HPH mills. Using Hardie's methodology and using 1991 figures, the capacity utilization ratt; can be estimated as shown in Table 4.11. Table 4.11: ESTIMATED CAPACITY UTILIZATION RATE Total log output (mission estimate: see paras 2.30) 36 million m3 Of which sawn (assuming 50% of total logs /!) 18 million m3 Sawnwood production (assuming 43% conversion /h) 7.7 million m3 Installed capacity (MOl estimate) 15.0 million m3 Capacity utilization rate (7. 7 /15) 51.3 percent Notes: 1! The share assumed by Hardie for the post-export tariff scenario. /]2 The rate estimated in Atlanta (op cit on pg.22). 4.53. The resulting capacity utilization rate is only 51 percent, which is considerably lower than the MOl figure of 70 percent and the Atlanta study estimate of 60 percent. It should also be noted from the above that, based on the above estimates for logs produced and the share of logs going to sawmills, the estimated sawnwood production would only be 7.7 million cu.m. for 1991, which is only 73 percent of the figure estimated by MOl for the same year, and almost identical to the ISA figure of 7.8 million. Tbe high capacity utilization rate calculated solely from MOl estimates seems to result from an overestimate of sawnwood production. The sawmilling industry bas probably already adjusted to the imposition of export tariffs on sawnwood by reducing output considerably. 4.54. Recovery rate. The Atlanta study concluded, based on estimates of inputs used and field investigations, that the recovery rate for the industry as a whole is about 43 percent, with about 46 percent for larger mills and 38 percent for smaller ones. These rates are very low, when compared with 52-55 percent in the Philippines, and levels of 60 percent or more in Japan. Explanations for the low rates could include low log prices, antiquated equipment, low quality of logs brought to the sawmills, and lack of training for workers. 4.55. According to FAO (op cit, see pg.35), wood recovery declined substantially, in fact at a rate of 7 percent per annum, during the period 1975 - 87. More importantly, after the fall in domestic log prices caused by the log expert ban, wood recovery declined by about 30 percent between 1986 and 87, i.e. wood consumption per unit of sawnwood produced increased by 30 percent during that period. This contrasts with the plywood industry, where wood recovery improved both during 1975 - 87 and after the log export ban. With the export tariffs and the consequent exit of smaller, more inefficient mills from the industry, the recovery rate is expected to improve somewhat. 4.56. Total factor productivity. Again in a sharp contrast with the plywood industry, total factor productivity declined in the sawmilling industry, at 3.6 percent per annum between 1975 and 87, and by 6.5 percent between 1986 and 87, suggesting that the industry as a whole bas become technologically less efficient over the long term, particularly after the introduction of the log export ban. This is mostly due to the aforementioned fall in wood recovery, as factor productivity either improved or declined marginally for labor, capital and energy. One possible explanation of this decline, as put forth by in the FAO studies, is the entry of inefficient producers into the industry particularly after the log export ban. Existing sawmillers must have also bad less incentives to save on wood usage. Although the export tariffs will surely "weed out" some sawmills as mentioned above, the industry as a whole will continue to be subsidized by low domestic log prices, continuing to discourage efficiency gains. 4.57. Production costs. The production cost structure was estimated by Atlanta as shown in Table 4.12 below. About 66 percent of total cost was accounted for by logs in 1986. When updated with 69 higher log prices (assuming US$90 per cu.m. for meranti) and accounting for inflation with the other items, the estimated total cost would be about US$300 per cu.m., which is higher than the unit cost for producing plywood, due mostly to the lower recovery rate and the assumed difference in at-mill log cost. As the domestic price of meranti sawnwood is reported to be in the range of US$175-200 (export quality) and US$100-125 (non-export quality), this does not make sense: a possible explanation is that logs used for sawmilling are much less expensive than the ones used for plywood production, which is logical with the reported lower quality of logs used for sawmilling. 4.58 Efficiency and competitiveness issues in sawmilling. The predominant policy event in this sector in recent times is the imposition, in 1989, of very high export taxes on basic sawn products7 • The eventual outcome of this measure is not yet known: so far, it appears that production from the sector as a whole bas not recovered to pre-tax levels: the proportion of production previously exported bas not found a domestic market as yet. Very low capacity utilization is now prevalent in the sector. 4.59 A primary motivation of the export taxes was to prevent the practice of minimally processing logs though sawmills as a means of circumventing the ban on export of logs: this was apparently a widespread practice prior to introduction of the taxes. Table 4.12: ESTIMATED PRODUCTION COSTS FOR SAWMILLING IN INDONESIA (CURRENT PRICES) 1986 1992 /~ Cost Item US$/m3 Percentage US$/m3 Percentage Logs 158.85 66.3% 209.30 70.00% Fuel 7.00 3.0% 8.01 2.68% Maintenance 7.10 3.0% 8.12 2.72% Handling 4.50 1.9% 5.15 1.72% Labor 18.95 8.0% 21.68 7.25% Deprec1ation 10.70 4.5% 10.70 3.58% Adm.mtstrat1on 15.00 6.3% 17.16 5.74% Other 16.50 7.0% 18.88 6.31% Total ProductiOn Costs 236.60 100.0% 299.00 100.00% Source: Atlanta (op c1t, pg.22), mission calculations. I~ Assuming: - 43.0% Recovery rate. - 14.4% Domestic inflation in US Doll:1r terms between 1986-1991. - 90 US Dollars per cu.m as log pnce. 4.60 Another intention of the measure was to drive raw material resources into the secondary (downstream) processing sector, in pursuit of higher value added within Indonesia. As suggested in para 4. 76, there was some initial stimulus in this regard but it seems not to have been sustained. 4.61 Anecdotal evidence collected during the sector review mission suggests that, even before the imposition of export taxes, many independent sawmills were experiencing difficulties in obtaining adequate log supplies for their operations. If so, this may to some extent explain why the expansion of the secondary 1 Export taxes for Meranti Merah Rose from a range of $5 -$50 per cum (depending on grade) to $250- $500 per cum. For Raaun, taxes went from $30- $40 per cum to $500- $1000 per cum. 70 wood processing sector has not persisted, because those processors will depend on sawmills for their basic timber inputs for further pr9~sing. This would particularly be the case if sawmills which are integrated with plymill operations have chosen to divert their ex~ort logs to the ply operation, instead of into production for the local secondary market. 4.62 Even if a government is able to justify industry policies aimed at increasing value-added, on grounds of employment priorities and regional development imperatives, this would not in itself justify the application of punitive export taxes across the spectrum of what is normally termed sawn timber - which is apparently the coverage of the taxes in this case. Some sawn product would attract prices in the same order as commodity grade plywood on the international market, and there would seem to be little economic reason why exports of such products should not be permitted. Limiting the application of taxes, either on a sawn product size basis, or some per unit price threshold, would achieve the objective of retaining value added, without loss of export markets. In fact, the present export tax regime does differentiate between large sized material and smaller dimensions, but even the smaller dimension material (anything greater than 6 mm thickness) is taxed at $250-$500 per cum, depending on species (unless the product is laminated, finger jointed, or decoratively moulded). At these rates, it is clearly not saleable on the international market to any significant extent. For a graduated export tax scale to work, the lower limit for small dimension or otherwise more processed and valuable product would need to be lowered significantly. It is not possible to determine what proportion of the 25 percent of total sawn production which was exported would be exportable again, if such a change were made. Some anecdotal evidence collected on the sector review mission suggests the change could be significant: one of Indonesia's larger concession and processing operations reported that, on their holdings, a significant volume of Merbau was present. This is a species which is unsuitable for plywood manufacture but for which the company bad developed a strong export sawn market, which was lost when the taxes were applied. This species is now left in the forest during logging operations and, according to the company, one effect has been a rise of around $10 per cubic meter in average logging costs for their operations as a whole. Overall, introduction of a graduated export tax, to encourage export of processed timber, would not onJy provide better support for the secondary processing sector, but might also introduce stronger competition into the log market (provided policies linking concessions to processing are eliminated). Woodworking 4.63. Definition. Woodworking is defined here to include all forms of secondary processing ofwood, including smoothing and shaping (e.g. molding) and assembly of wood (e.g. window frames). Since furniture and furniture components (sometimes called tertiary processing) are quite different from other types of downstream industries in terms of value added, employment effects, nature of markets, and skills needed for production, they are treated separately at the end of this section. As woodworking products are extremely heterogenous, and because most of the plants are extremely small, their number and other statistics are difficult to quantify. Therefore, in this review the focus is placed on selected types of products where data are available. 4.64. Main product groups. The Atlanta study estimated the shares of major products in total output volume for woodworking products. The largest share, about one-third, belonged to building materials, including doors, window frames, and shingles. Moldings was the second with 29 percent. "Others" included wooden tools, toys, coffins, musical instruments, chopsticks, and boat parts. (fable 4.13). 4.65. Plant size. . The industry is dominated by small and household/cottage plants; data on household/cottage plants are however not available. According to Hardie (op cit pg. 67), 1,680 small-scale plants existed for building materials, handicrafts, and wooden containers alone, as opposed to 85 large and medium scale ones. 71 Table 4.13: BREAKDOWN OF WOODWORKING ' . OUTPUT BY PRODUCT Product Group Share in total output volume (%) Building materials /~ 32 Parquet I Moldings 29 Packaging material 7 Poles 3 Others 28 Total 100 Source: Atlanta, 1987 (op cit on pg.22). Note: /~ Does not include prefabricated housing. 4.66. Output, installed capacity, demand. The major woodworking products monitored by MOl are window frames and prefabricated housing. Their output, installed capacity and demand are summarized in the table below. Although their output has expanded rapidly over the last five years, they are still insignificant when compared with plywood and sawnwood. While prefabricated housing is mainly directed to the domestic market, window frames are increasingly being exported: in fiscal 1991192, nearly 60 percent of their output was exported (table 4.14 below). 4.67. With small-scale plants, most of the woodworking products are directed to extremely localized markets near production facilities. According to Hardie (op cit pg.67), 23 percent of building materials, 29 percent of wooden containers and 13 percent of handicrafts manufactured by small-scale producers in 1986 were directed to their sub-districts. Virtually nothing was exported from these three categories. Table 4.14: PRODUCTION, INSTALLED CAPACITY AND DEMAND FOR WINDOW FRAMES, BY FISCAL YEAR - ACTUAL AND PLANNED -actual- (folal growth -planned- 98/88 - 9\/92) 87/88 (in m3) 88/89 89/90 90/91 91/92 92193 93/94 94195 95/96 Installed capac1ty 458,6\9 471,300 500,000 n5,ooo 875,000 90.8% 1,050,000 1,200,000 1,300,000 1,450.000 Actual production 382,200 414,200 460,000 691,900 852,400 123.0% 950,000 1,150,000 1,175,000 1,200.000 Capacity Utilization 83.3% 87.9% 92.0% 95.4% 97.4% 90.5% 95.8% 90.4% 82.8% Domesttcally Sold 340,000 360,000 390.000 450,000 500,000 47.1% 550.000 600,000 700,000 800,000 (share in total dem.) 89.0% 86.9% 84.8% 65.0% 58.7% 57.9% 52.2% 59.6% 66.7% Exported 42,200 54,200 70,000 241,900 352,400 735.1% 400,000 550,000 475,000 400,000 (share tn total dem) 11.0% 13.1% 15.2% 35.0% 41.3% 42.1% 47.8% 40.4% 33.3% Source: Ministry of Industry. 72 4.68. Number and regional distribution: The Atlanta study estimated the regional distribution of woodworking plants aCC9rding to their size, without trying to specify their exact numbers, as shown in Table 4.15 below. Forty percent of the large an~ medium scale plants established in Kalimantan are integrated with sawmills as a further stage in downstream processing, while 58 percent of small-scale. plants found in Java are obviously located away from resource supply, oriented towards local consumption. Table 4.15: REGIONAL DISTRIBUTION OF WOODWORKING PLANTS Region Large and Medium scale Small scale establishment (%) establishments (%) Sumatra 25 14 Java 13 58 Kalimantan 40 6 Sulawesi 10 9 Flores, Timor 0 11 Maluku 7 1 Irian Jaya 5 1 Total 100 100 Source: Atlanta (op cit on pg.22). 4.69. Distribution of woodworking production capacity, as well as output, by region is as shown in Table 4.16 below. In marked contrast with other wood-based industries, production facilities in woodworking are heavily concentrated (57 .6 percent of the total) in Java. 4. 70. Capacity Utilization Rates, Recovery Rates. It is extremely difficult to estimate production capacity for woodworking plants, since the capacity of the same machine can vary significantly depending on: (a) whether or not it is used for series or individual production; (b) the wood species used; and (c) the skills level of workers. It then becomes difficult to calculate capacity utilization rates. With this caveat, the Atlanta study estimated that for large and medium scale plants, the capacity utilization rate would be about 30 percent. For small and household/cottage plants, the Atlanta study concluded that the capacity utilization rates cannot be calculated since with these plants production is done mainly by hand. The wood recovery rate was estimated to be 28 percent in the same study. These rates were based on field investigations. 4.71. Furniture: Output, Installed Capacity, Demand. Like other woodworking products, the furniture industry began its growth from a very small base. Although the installed capacity and production for furniture and its components more than doubled between fiscal 1987/88 and 1991192 (see Table 4.17 below), the industry is dwarfed by the plywood and sawmilling industries. It should be noted, however, that the structure of demand has changed considerably in recent years~· the share of exports in total demand for furniture and its components has risen during the same period from about 10 to 40 percent. This can be substantiated by the increase in export earnings, which went from US$9 million in 1986 to US$313 million in 1991. 73 Table 4.16: WOODWORKING PRODUCTION .CAPACITY AND ACTUAL OUTPUT BY PROVINCE, 1992 No. of Installed Actual Capac1ty Av. Cap. Share in Province Est. Capacity Product1on Utilization per Est. Total (cum) (cum) (cum) Capacity D.I. Aceh 4 19,480 7,353 37.7% 4,870 0.4% North Sumatra 28 260,930 218,705 83.8% 9,319 4.7% West Sumatra 6 29,450 13,853 47.0% 4,908 0.5% Riau 41 293,762 261,990 89.2% 7,165 5.3% Jambi 20 128,587 109,643 85.3% 6,429 2.3% Benglculu 2 -· 23,000 10,396 45.2% 11,500 0.4% South Sumatra 27 229,800 174,075 75.8% 8,511 4.2% Lampung 6 20,405 8,273 4.5% 3,401 0.4% DKI Jakarta 127 677,349 590,451 87.2% 5,333 12.2% West Java 155 986,381 918,882 93.2% 6,364 17.8% Central Java 41 295,914 265,453 89.7% 7,217 5.4% 0.1. Yogyakarta 0 0 0 0.0% 0 0.0% East Java 189 1,228,835 1,119,141 91.1% 6,502 22.2% West Kalimantan 42 343,970 295,476 85.9% 8,190 6.2% Central Kalimantan 19 135,280 105,187 77.8% 7,120 2.4% South Kalimantan 25 152,684 119,668 78.4% 6,107 2.8% East Kalimantan 47 293,070 250,450 85.5% 6,236 5.3% North Sulawesi 34 41,673 27,089 65.0% 1,226 0.8% Central Sulawesi 8 62,850 48,067 76.5% 7,856 1.1% South-East Sulawesi 14 16,655 4,880 29.3% 1,190 0.3% South Sulawesi 10 73,120 55,173 75.5% 7,312 1.3% Bali 5 6,855 5,656 82.5% 1,371 0.1% West Nusa Tenggara 3 2,910 2,399 82.4% 970 0.1% East Nusa Tenggara 14 10,921 7,876 72.1% 780 0.2% East Timor 0 0 0 0.0% ERR 0.0% Maluku 35 101,119 81,337 80.4% 2,889 1.8% Irian Jaya 12 95,000 63,827 67.2% 7,917 1.7% Total 914 5,530,000 4,765,300 86.2% 6,050 100.0% Source: Ministry of Industry. 4. 72. Furniture: Number and regional distribution. It was estimated in 1987 that there are 137 large and medium scale establishments, and 5,600 sma~l scale ones in Indonesia (Atlanta, op cit pg. 23) Again the large and medium ones are generally integrated with primary processing plants, but its share in the total number (6 percent) is extremely small, even compared to woodworking. The regional distribution of all establishments was estimated in the same exercise (see Table 4.18 below); it shows heavy concentration in Java, with 80 percent or more of both size groups located on the island. This can be explained by: (a) closeness to markets; (b) abundance of skilled labor; and (c) availability of infrastructure. 4.73. Furniture: Employment. The total number of employees estimated for the furniture industry, using the benchmarks of 42 persons in a large and medium establishment and 7 in a small one, was 45,000 in 1984 (Atlanta op cit pg.22). 74 4. 74. Furniture: Capacity Utilization Rates, Rewvery Rates. There are the same problems with calculating capacity utilization rates and recovery rates that exist with the woodworking industry. Based on MOl statistics, the capacity utilization rate can be calculated to be 90 percent in fiscal 1991/92, although the caveats mentioned in the woodworking section appJy. As for recovery rates, it was found during field interviews that about 40 - 50 percent of log inputs are recovered as finished products. Table 4.17: PRODUcrJON, INSTALLED CAPACITY AND DEMAND FOR FURNITUREIFUR.NITURECOMPONENTs, BY FISCAL YEAR - ACTUAL AND PLANNED • aciWII· (fOIAI growth - plazmed- 98/88 - 91/92) 87188 (in m3) 88/89 89190 90191 91192 92193 93194 94195 95196 lnstaUed capacity 1,319 1,500 1,600 2,350 2,675 102.8% 3,000 3,500 3,800 4,000 AciWII production 1,159 1,226 1,400 2.006 2,411 108.0% 2.800 3.000 3,100 3,150 Capacity Utilization 87.9% 81.7% 87.5% 85.4% 90.1 i) 93.3% 85.7% 81.6% 78.8% Domestically Sold 918 950 1,000 1,050 1,100 19.8% 1,200 1,300 1.400 1,500 I (share in loU.) dem.) 79.2% 77.5% 71.4% 52.3% 45.6% 42.9% 43.3% 45.2% 47.6% Exponed 241 276 400 956 1,311 444.0% 1,600 1,700 1,700 1,650 (share in lOla) dem) 20.8% 22.5% 28.6% 47.7% 54.4% 57.1% 56.7% 54.8% 52.4% Source: Ministry of Industry. Table 4 18· REGIONAL DISTRIBUflON OF FURNITURE PLANTS Region Large and Medium scale Small scale establishment (%) establishments (%) Sumatra 0 11 Java 84 80 Kalimantan 9 1 Sulawesi 0 7 Flores, Timor 0 0.6 Maluku 0 0.2 Irian Jaya 7 0.2 Total 100 100 Source: Atlanta (op cit on pg.22). 4. 75. Efficiency and Competitiveness issues in secondary wood processing. The policy ofimposing prohibitively high export taxes on sawnwood, instituted in late 1989, was aimed at establishing further processing of wood products, particularly woodworking and furniture products, as a major exporting industry for Indonesia. Indeed, both foreign and domestic investment in this industry jumped in 1990, and exports of these products increased sharply. However, investment in this industry appears to have tapered off since 1990, and failures and dropouts seem to have increased noticeably in these activities. 75 4. 76. BKPM data show that both dom~tic and foreign investment in the wood processing sector measured in terms of amounts involved and number of cases approved, peaked in 1989 and 1990, and declined in 1991 and in the first half of 1992. BKPM data show investment proposals on approvals basis but do not show the extent of investment actually implemented. 8 Table 4.19 shows Indonesia's imports of woodworking tools and machinery in the 1985-1991 period. 9 If it can be assumed that total investment in the secondary wood processing industry changed broadly in parallel with imports of machinery and tools shown in Table 4.19, it appears that total investment in this industry, having increased in the 1986-1990 period, decreased in 1991. Table 4.19: INDONESIA: IMPORTS OF WOODWORKING TOOLS & MACHINERY (US$ Million, 1985-1991"/) Description of Woodworking Tools 1985 1986 1987 1988 1989 1990 1991 & Machinery Machines, Tools 4.5 7.7 4.2 Sawing Machines 15.8 22.1 16.8 Plannmg, Milling or Moulding Machines 19.4 36.6 19.4 Gnnding, Sanding or Poi.Jslung Machines 7.1 12.9 10.1 Bending or Assembling Machines 2.5 9.4 4.6 Drilling or Morticing Machines 1.7· 3.2 2.3 Splitting, Slicing or Paring Machines 5.8 5.2 7.2 Other Machines for Working Wood 58.6 128.2 91.7 Parts of Machines for the above (8465) 7.6 9.9 10.2 Sawing Machines for Working Wood 3.7 0.0 3.2 14.0 Accessories/Parts for CCCN 8446 or 8447 5.9 7.1 8.5 10.1 Machines for Treatmg Wood 5.6 7.6 19.6 42.7 TOTAL OF ABOVE 15.2 14.7 31.3 66.7 122.9 235.2 166.2 Source: •f Classlficahon Schedules changed in 1989, from CCCN to HS. So, there may be a difference in coverage between the data for 1985-1988 and those for 1989-1991. 4.77. Not all of the apparent contraction in investment interest in the sector should be attributed to domestic factors: there has been a slowdown in the growth of export demand for secondary processed wood products caused by the economic recessions in industrial countries, especially in Japan and the United States. Indeed, the income elasticity of demand for woodworking products and furniture is known to be relatively high; woodworking products being used mainly in housing/building industries and furniture being consumer durables. Thus, demand may be an important factor causing the current financial difficulties and investment slowdown in these sub-sectors in lndone$ia. 1 A recent study by IFC/MIGA's FIAS states: wBased on the analysis of the data published by both BKPM (approvals) and Bank Indonesia (Implementation), we have estunated that in the period 1968 to 1987 only 31% of the value of BKPM approved projects (Including cancellations) have been realized. A similar ratio (35%) for the years 1967-September 1988 appears in a recent publication of FDI in Indonesia by an Australian researcher. w See IFC/MIGA's FIAS (February 1990), p.13. 9 Table 7 includes only the selected SITC codes that are judged to be definitely related to sawmilling and woodworking. Also, since Indonesia changed its trade classification system in 1989, it is not certain that data shown for the period 1985-1988 and those for the period 1989-1991 are precisely consistent. 76 4.78. However, the sector. review mission encountered considerable anecdotal evidence that woodworking and furniture producers are experiencing considerable difficulties in procuring adequate supplies of logs or sawnwood. 4.79. The apparent diminution in investor interest in secondary wood processing appears to have at least some origin in domestic policy. These industries are dependent on the existence of a healthy sawmilling sector, and that bas been affected by export taxes: counterintuitive as the argument may seem, it may well be that a regaining of at least some part of the sawn export market by Indonesian sawmills may have spin-off benefits for secondary processing. In peninsular Malaysia, it bas become evident that restriction of sawnwood exports bas reduced the supply of needed material to downstream processors. 4.80. The extent to which Indonesia will wish to pursue promotion of the secondary processing sector will, in view of the general policy objectives of the Government, relate closely to the potential of the sector to deliver high employment. Some analysis of this matter is therefore pertinent, and can be undertaken using standard industry data on employment and value added. Annex 4 to this review describes a simple spreadsheet model used to explore this issue, and reports the results of its application. The basic approach in the model has been to compare the employment and value added impacts of shifting log volume from other forms of processing to secondary processing. 4.81. The model shows that if 20 percent of total log supply were shifted to secondary processing (from plywood manufacture), a net increase in value added of 10 percent (around $370 million in national terms) and 11 percent (66 000 workers) in employment would result. For the sake of comparison, it can be calculated that a rise in recovery rates in sawmilling of 6 percent, and plywood manufacture of 5 percent, would achieve the same gain in valued added, but would produce employment increase of only 3 percent. 4.82. This simple analysis does not assess the investment costs involved in increasing secondary processing, nor those needed to produce the recovery rates adopted. Moreover, it ignores a positive linkage between the sawmilling and secondary processing sectors: if additional secondary processing capacity is integrated with sawmilling, one result will be a rise in sawmilling recovery, because of the ability to utilize smaller sizes off the saw. 4.83. This analysis is not meant to imply any recommendation that Indonesia should attempt to boost secondary processing by legislative means or administrative fiat. Rather, it is intended to indicate that if the secondary processing industry is able to acquire both the log supplies and technology needed to become a competitive supplier internationally, then significantly higher employment per unit of log volun:.e input (now the limiting input in the forestry sector) would result. Pulp and Paper 4.84. Output, Installed Capacity, Demand. There bas been a rapid expansion of production capacity in the pulp and paper industry. Between 1980 and 1991, the av~rage annual growth was between 18 and 20 percent per annum. Output grew by 20 percent per year from 0.83_to 1.44 million tons and installed capacity increased by 21 percent per annum from about 1 million tons to 1.7 million, between 1987 and 1990 (see Table 4.20 below). Investment in pulp expanded particularly fast between 1988 and 1991. Such high growth in output was fueled by a rapid rise in consumption of paper, which practically doubled during the period. It grew by 10 percent per annum between 1980 and 1990, and is expected to grow at 8.5 percent per year between 1993 and 2000, slowing down further to 6.5 percent per year between 2000 and 2010 (Hone, op cit, pg.44). In the year 2000, Indonesia is projected to produce 3.9 million tons' of paper (nearly three times the level in 1991), of which 3.0 million will be consumed domestically (more than twice the level in 1991) and 0.9 million tons will be exported (five times the level of 1991). Some projections given in a consultancy report 10 prepared for the forthcoming Bank industry sector review give a range of 5.6-7.1 million tons for domestic demand per annum by year 2010. Table 4 20· . OUTPUT INSTALLED CAPACITY AND DEMAND FOR PAPER BY YEAR 1987- 1990 ' 1987 1988 I 1989 1990 Producuon (m ton) Capacity 980,000 1,162,000 1.481.000 1,716,000 1987- 1990 Paper 826,500 931,400 1,154,800 1,438,100 - Newspnnt 121,800 140,000 143,700 157,100 - Writing & Printmg 283,800 317,800 417,700 503,800 - lndustnal Paper 414,400 466,700 586,900 771,400 -Others 6,500 6,900 6,500 5,800 Utilization (%) 84.3% 80.2% 78.0% 83.8% lmpon (m ton) Paper 144,400 110,200 124,700 123,600 1987- 1990 -Newsprint 6,900 7,200 5,100 13,800 - Writing & Printing 9,700 9,100 13,600 16,100 - lndustnal Paper 119,900 85,000 90,800 44,500 -Others 7,900 8,900 15,200 49,200 Pulp 232,500 199,300 208.000 216,700 Waste Paper 225.5 323.7 382.5 463.4 Expon (m ton) Paper 188,479 213,409 204,366 190,329 1987- 1990 -Newsprint 24,807 21,251 3,220 0.042 - Writing & Printing 76,151 96,079 121,844 112,913 - Industrial Paper 86,635 93,808 79,251 77,180 -Others 0.886 2.271 0.051 0.194 Pulp 7,500 7,700 86,481 180,875 Waste Paper 0 0 0 0 Consumpuon (m ton) Paper 782,421 828,191 1,075,134 1,371,371 1987- 1990 - Newspnnt 103,893 125,949 145,580 170,858 - Writing & Printing 217,349 230,821 309,456 406,987 - lndustnal Paper 447,665 457,892 598,449 738,720 -Others 13,514 13,529 21,649 54,806 Manpower 18.583 19,724 29,530 33,326 1987- 1990 Indonesia 18,298 19,444 29,076 32,884 Expatriate 0.285 0.28 0.454 0.442 Source: Indonesian Paper Trade Directory, 1991; APKI Jakana, June 1991. 4.85. Imports. With the expansion of the domestic industry, the share of imports in domestic consumption dropped from 19 percent in 1987 to 9 percent in 1990. It also decreased in absolute terms, from 0.14 to 0.12 million tons: this however is due mostly to a sharp decline in imports of industrial paper and pulp, as imports of newsprint, writing and printing paper and waste paper increased during the period. Tariffs on most grades of paper have been reduced from 40-60 percent in the early 1980s to 30 percent in 1991. The duties on newsprint, waste grades, and imported pulps are very low, at 5 percent. However, the level of effectiv~ protection remains extremely high, and it may be difficult to expand paper exports substantially without facing the risk of countervailing duties in some markets. 4.86. Exports. In 1987, Indonesia became a net paper exporter: exports of paper (mostly printing and writing grades, and industrial papers) remained at about 0.2 million tons during the period. The export share of total production dropped considerably, however, from 19 percent to 11 oercent, as domestic demand 10 Jaakko Poyry Consultants (1993) Microview on Indonesian Forest Based lndustrv, World Bank. 78 rose. Export prospects are quite good for bleached hardwood pulps, and printir.g and writing papers, to East Asia, especially Japan, Korea, Taiwan, and the People's Republic of China. 4.87. Number and regional distribution. In 1991, the pulp ~d paper mills were distributed by ownership and region as shown in Table 4.21 below. In terms of ownership, the salient features are: (a) the large (35.8 percent of total installed capacity) share of the public sector in the pulp industry, which incidentally is higher than in any other wood-based industry (there are plans to privatize this sector, and some sales of public operations were made in 1992); (b) the large (42 percent) share of foreign ventures in the pulp industry; and (c) the dominance of private domestic operators (69.2 percent) in the paper industry: the paper industry in Indonesia is dominated by three conglomerates, and this situation is expected to intensify in future. In terms of regional distribution, it should be noted that: (a) virtually all production capacity of pulp is split between Sumatra (57 .2 percent) and Java (41.4 percent), notably with none in Kalimantan; and (b) most (85. 7 percent) of the paper producing capacity is located in Java, with the rest situated in Sumatra. There is likely to be further pulp and paper investment in Sumatra, with lndah Kiat's investment plans between 1992 and 1995. Table 4 it· DISTRIBUTION OF PULP AND PAPER Mll..LS BY OWNERSHIP AND REGION , 1991 Installed Capacity (tons per aMum) Nos. Pulp Share Paper Share No. of Mills and Status - State Enterprises 6 396,400 35.8% 421,900 13.8% 1991 - Private Company Domesuc 30 246,100 22.2% 2,124,700 69.2% - Private Company Foreign 5 465,000 42.0% 523,900 17.1% Total: 41 1,107,500 100.0% 3,071,500 100.0% Locauon of Mills -bva 35 458,500 41.4% 2,631,100 85.7% 1991 -Sumatra 5 633,000 57.2% 410.,400 13.4% ·Sulawesi 1 16,000 1.4% 30,000 1.0% Total: 41 1,107,500 100.0% 3,071,500 100.0% Souree: Indonesian Paper Trade Directory, 1991; APKJ Jakarta, June 1991. 4.88. Production costs and prospects. Provided it can maintain capacity utilization and reasonable wood costs, Indonesia has prospects of being amongst the lowest cost producers of pulp in the world. A consultancy report (see Jaakko Poyry op cit on pg.54) done for the Bank's forthcoming Indonesia industry sector review shows a calculation of prices needed for hypothetical pulp operations to generate market returns to capital in the nine most competitive producer countries: Indonesia's price is $497 per air dry tonne (ADT); followed by Venezuela at $550/ADT, and then other Southern American and African countries. The same study calculates that, if all plans for pulp production in Indonesia are realized, the country will produce 20% of global production of bleached kraft short fibre pulp by 2005. This would have a market value, in 1992 prices, of US$2.2 billion p.a. 4.89. Most paper produced in Indonesia now is sold on the domestic market at internationally competitive prices: the major exception is newsprint, which sold in 1992 for Rp117.0/kg on the domestic market, compared to an international price of Rp870/kg for that product. The government introduced a 20% duty and surcharges on newsprint in 1992. Some paperboard products also sell at prices up to 25% higher than international prices on the domestic market. 4.90. The printing and writing paper market in Indonesia is dominated by a single producer- the Sinar Mas group - which appears to be aiming to become even more dominant. At present, this group is pricing aggressively on the domestic market, and prices of printing and writing paper have dropped from Rp.2000/kg in 1989, to Rp.1350/kgby October, 1992. Jaakko Poyry consultants (see op cit pg.77) have carried out some 79 analysis which suggests that this price level - which is slightly below international parity - is significantly below costs of production plus capital charges. It may therefore be a temporary phenomenon related to the market share strategy being pursued by Sinar Mas. 4.91. On the basis of these observations, Indonesia's prospects m the pulp and paper sector appear relatively good. However, the international pulp and paper market is notoriously cyclical and highly competitive, and no single producer country can hope to gain a predominant position in it. In recent years, the pulp cycle in particular has been in decline: spot prices on Asia markets have recently ranged from US$430 to 460 per ton. A major impact in these years has been the entry of large volumes of Brazilian pulp. Increases from this source will now taper off: the new uncertainty could be Russia, which has large export capacity for pulp, and presumably will be inclined, in the short term at least, to use this as a means of generating much needed foreign exchange. 4.92. Expansion of Indonesian capacity will, on present indications, be based on exports, and on large scale operations. These will require relatively expensive pollution control investments - small, domestic scale mills may be able to dispose of waste in waterways, but this will not be an option for large mills, particularly in relation to control of dioxin and chlorine. 4.93. Although the pulp and paper sector in Indonesia is presently strongly linked to the natural forest resource - the major focus of this review - through the operation of the HTI scheme, in future this linkage will weaken, as the sub-sector becomes more reliant on plantation resources under rotation on lands already committed to that purpose. From this point of view, the economic and environmental issues involved in pulp and paper making will become more closely related to the generic ones of industry growth in Indonesia: industry, trade, and protection policies; competitiveness; the role of government and public enterprises; pollution abatement. These issues will be dealt with extensively in forthcoming Bank reports on the industry sector and environmental management in Indonesia. 81 CHAPTER V PRICING INDONESIA'S FOREST RESOURCES Introduction: The Role of Price 5 .1. It has been implied at various places in this report that the price of standing timber is presently set too low, and that this is distorting both the log supply market, and the efficiency and competitiveness of the processing sector. This chapter will present the case for log price rises in Indonesia. Although revenue impacts from doing so are calculated, it is a central argument of this chapter that the reasons for raising prices go well beyond revenue, into basic issues of sustainability and the structure and nature of the forest products sector, and some indicative calculations of value added outcomes are presented in support of this point. 5.2. Price rises alone - especially if applied on a uniform basis- will not achieve all the objectives of sustainability and efficiency of resouree use, and this reservation should be explained clearly at the outset. Across-the-board rises will not, without accompanying support in the area of supervision and enforcement, increase efficiency of wood utilization: high grading and more illicit. removals might otherwise be the result. Moreover, the means by which price is assessed and collected is important: if, for example, volume is assessed in the forest, rather than at the log dump (and if, at the same time, logging operations are confined to a designated area), then this will create an incentive to extract the maximum volume from the stand. If, as a second example, part of the price calculated for logs is in fact a performance bond, rebatable to the concessionaire upon evidence of acceptable and well controlled operations, then a strong incentive to comply with concession conditions is built into the system (see para 6. 76). 5.3. There are two compelling reasons why standing timber revenues collected by government should rise in Indonesia. First, it is the intention of the Government of Indonesia, and presumably of a significant proportion of the private sector, that forestry should be a long term industry for Indonesia. Measures to bring about sustainability will not be costless, and it must be made evident to all that the investment in the resource is worthwhile: this is highly dependent on the value of that resource. Moreover, the price of plantation material - especially that which will directly compete with natural forest material - will be conditioned by natural timber prices, in a market which will be dominated by natural timber output for some considerable time to come. The Government of Indonesia cannot expect private investor interest in plantation (without ·recourse to large subsidies) to be high, if low price structures for natural standing timber are institutionalized. 5 .4. The second reason relates to processing industry structure and performance. The issues in this regard have been raised at various places in Chapters IV above, and have also been raised by GOI (for example, in its Action Plan for Forestry Sector Development in Indonesia). Sustainability requires that there be a limit on how much natural forest area can be logged in a given time frame: the limit may vary according to interpretations of sustainability (see paras 1.21 and 1.22), but ultimately some limitation on output will apply. It is in the national interest that as much commercial volume as possible be taken from such areas (consistent, of course, with silvicultural and management prescriptions), and that the maximum gain, in terms of genuine value added arises from whatever is done with the volume from then on. The more competition that can be introduced into the process, the more likely it is that the most efficient and competitive processors will emerge as predominant users of the resource. 5.5. With these observations in mind, it is appropriate to review the current status of economic rent collection for standing timber in Indonesia, and the extent to which this might be changed. 82 Fees for Standing Timber: Economic Rent 5.6. Past and· present system of government charges. This discussion is confined to revenue collection from sale of logs, by government. "Although the sawn timber export taX is technically a revenue generator, n is discussed separately in paras 4.58 to 4.62. 5.7. In the 1979's and early 1980's, fees for standing timber were assessed on the basis of actual volumes assessed at the logging site. In 1985, the system was altered, to assessment based on processed output, using a 50% recovery factor. 5.8. The main element in the government's collection of fees at present is the reforestation Jevv {DR), which was introduced via presidential decree in 1980, at $4/cum, and bas since been raised to $7/cum (1989) then $10/cum (1990), and $15/cum (1993). Funds from collection of the DR are accumulated in the Reforestation Fund, managed by the Ministry of Forestry. This fund is used to finance the IITI and other works as sanctioned by the Minister. As noted in para 3. 71, about $900 million is now in the Fund. Some $125 million bas been allocated to applicants for assistance. 5.9. The second major element in fee collection is the forest products rovalty (IHH) which is set according to a tariff, approximating 6% of the delivered price of logs. This revenue is transferred to the Ministry of Finance, which then distributes it as follows: provincial governments (40%); local governments (20%); national rehabilitation of forest areas (25%); regional forestry (15%). 5.10. There are other charges levied: a forest concession license fee; land and building taxes; and scaling and grading fees; but together these amount only to some 3-4% of total government fee collections. 5 .11. The basis of fee calculation was altered, on an experimental basis, to self-assessment, by individual concessionaires or the industry as a group, in 1990 (see para 3.75). 5.12. On the basis of official log removals averaging about 25 million cum, and an average per cubic meter total government fee collection of $15.40/cum, total government revenues from logging in recent years have averaged $385m per annum. This makes forestry the second largest (after oil and gas) natural resource revenue source for the Indonesian Government. 5.13. Were the Indonesia Government able to collect revenues for illegally removed timber (see paras 2.28 to 2.30), and on the basis of the expected DR fee, which will take average total fee collection to about $20/cum, GOI's revenues from 1993 onwards would be on the order of $700- $800m p.a., although these would decline towards 2000, as lower Jog output limits come into force. 5.14. The economic rent issue. A crucial question for Indonesia is: bow much revenue should be collected as standing timber fees from its forest resources? TJ:iis question needs to consider the balance between the nation's desire to have a major forest processing export sector, on the one hand, and on the other hand the fact that, of all factors of production involved in that sector, logs are the most limiting, with regional shortages already occasionally apparent, and according to GOI's projection a declining supply from the natural forest areas over the next three decades. 5.15. The normal means in a market economy by which a scarce resource is allocated amongst users is the price mechanism. In the case where supply is limited by biological and administrative determinants, as is the case with Jogs from the natural forests, the selling prices of Jogs in the forest might have been expected to have moved upwards faster than prices of other products. In fact, from 1985 to 1991, the wholesale price index for the log extraction and processing sector as a whole rose by 150%. Had fees for standing timber risen by the same proportion over the same period, they would have reached an average of about $33 per cum in the latter year: as noted earlier they were actually about $15/cum in that year. 83 5.16. There is no apparent reason why logging costs will have risen disproportionately over this period, and therefore it would seem that fees for standing timber are well below what the market might bear, and that therefore Government is not extracting full economic rent for standing timber. This is borne out by almost all recent studies of this question. Table 5.1 summarizes some recent calculations of the revenue situation in Indonesia forestry. Table 5.1 COMPARISON OF RECENT ESTIMATES OF ECONOMIC RENT ESTIMATES FOR LOGS IN INDONESIA At mill Costs of Actual fee Log price Logging Available Collected as SOURCE assumed assumed Rent % of Available Rent . Domestic log Rrice base APfll!' 75 54 21 84 Sutopo, Darusman Y 31 World Bank - ITI'O 2' 85 33-40 45- 52 19- 33 Reid-Colli.ni ~/ 85 40-45 40-45 25- 35 FAO~ 29 Source: 11 APID: Report on Forestrv Economic Rent, October 1992. 1:/ Cited in "Tinjauan Economic Rent di Indonesia" (D. Darusman) in proceedings, Aspek Ekonomi Pengusahaan Hutan, Jakarta, 6-7 October 1992. Jl World Bank- ITTO commiss10ned study by Jaakko Poyry Consultants Tropical Deforestation in As1a and the Market for Wood, forthcommg 1993. 5_1 Reid Collins "Log Revenue Systems" in Concession Management & Inspection Services Project Workshop DG Forest Utilization, October 1992. ~I FAO Forestry Studies, under World Bank Forestrv Institutions and Conservation Project, 1991. 5.17. Eliminating the extreme estimate of APID, some consistency emerges among these estimates, with a range of rent capture from the existing fee structure of between 19% and 35% of potential. Cost estimates for logging and extraction in the studies vary through a range of $33/cum to $45/cum. For the most part, these cost estimates are based on field questioning of operators, and seem to include varying levels of profit and risk: in some data collected in the field work of Reid-Collins (cited under Table 5 .1) for example, "administration, overhead and other" costs ranged from $2.62/cum to $28.92/cum in the individual responses. 5.18. Engineering based studies of logging - especially if based on the optimal technology possible in the Indonesian situation - would undoubtedly show much lower operating cost figures. Some estimates made in the World Bank - ITTO study cited in the table imply logging operation costs of less than $20/cum. To this would need to be added a reasonable return to capital invested, but it is difficult to determine bow much capital ~ invested in the sector. Some studies (the APID study, the Reid-Collins study) suggest depreciation and amortization costs of $5 per cum or less, which, at a conservative depreciation figure of 10% 84 per annum, suggests a capital investment of $50 per cum. Allowing a generous risk and profit return to this capital investment of 30% ($16. 66), and adding in depreciation, amortization and operating costs of $25 would yield a total extraction cost of about $42 J>er cum, inclusive of returns to capital and risk. Adding in the $22/cum government charges would suggest that processors will" be paying around $64 per cum at. mill for logs from their own concession operations. 5.19. It is difficult to be precise on the matter of domestic delivered log price. Most logs in Indonesia are not sold on the open market, but are transferred through integrated operations: most plymills, which are the major consumers of logs, are linked under corporate ownership to concession operations. 5.20. Logs, moreover, are a variable commodity: the mix of species, and of quality grades, is important when considering an average price. It is quite likely that the average species and quality mix of all logs sold in Indonesia is below that of, say, an average shipment of export logs (primarily ply logs and good quality sawlogs) from Sabab or Sarawak in Malaysia. Comparison of average prices of all Indonesian logs, with Malaysian export logs, would therefore overestimate the gap between Indonesian domestic and international parity log prices. 5 .21. However, it is more reasonable to compare the higher quality logs supplied for manufacture of export grade ply in Indonesia, to export shipments out of Eastern Malaysia. In essence, the comparison is then between the typical Meranti logs, which comprise the bulk of material used for this purpose in each market. In Indonesia, according to APKINDO, the price of this material at mill bas recently been in the order of $90/cum. Internationally, the f.o.b. price of meranti logs bas fluctuated widely in recent years, over the range of $100/cum to $200/cum. Table 5.2 is a compilation of some recent log and sawn price information from Malaysia. 5.22. Obviously, there will be cases in Indonesia where a combination of poor quality logs, difficult site conditions and remoteness from mill sites might warrant an average standing timber fee of $20/cum, or even less. The Concession Management component under FICP ll will provide a basic formula which will determine a scale of fees, allowing for some of the species and locational differences. However, this formula will need to be anchored with an eStimate of what the average standing timber fee should be in Indonesia. The indication from the sources and analysis given above is that this average could probably be set somewhere in the $30 - $50/cum range, on the basis of domestic at - mill prices. 5.23. However, this order of fee would not collect full economic rent, because any reasonable definition of economic rent will be based on international, not domestic, prices: and as discussed, international prices (at least for a major component of total log supply) are well above the domestic levels estimated. If, therefore, the Government wishes to use standing timber fees as a mechanism to allocate timber amongst the most efficient users, and to promote processing competitiveness internationally, it would need to implement further standing timber fee rises, either via an auction system, where feasible, or by the use of administered prices which follow market forces as closely as possible. • 5 .24. It is not possible to be precise about the extent to which the surpluses implicit in the sector arising from low government rent capture are dissipated in inefficiency or illicit incentive payments, as opposed to accruing to windfall profits. This is an important issue, because windfall profits ·might be re- invested in productive areas elsewhere in the economy, or at least be subjected to taxation, whereas wastage is not recoverable in any form. Perusal of Table 5.2 shows that for the Malaysian case over years 1986-1990, the differential between log and sawn f.o.b. prices is small, implying negative value added in sawing given that around 2 cubic meters of log volume is required per cum of sawn output. Presumably, quality differentials must explain part of this. See also Box 5 .1. 85 Table 5.2: PRICES OF MALAYSIAN MERANTI LOGS, AND SAWN TIMBER FROM FROM INDONESIA AND MALAYSIA Meranu Log Prices Sawnwood Prices Year Importers Dark Red Export Urut Value FOB Sale Price Meranu in Sabah I~ In Japan I!! Europe I£ lndonesta Malaysia 1980 NA 195 365 215 186 1981 NA 156 314 161 153 1982 NA 156 302 151 160 1983 NA 145 304 159 171 1984 NA 167 307 153 170 1985 NA 136 276 154 148 1986 101 . 151 267 209 160 1987 181 221 276 169 174 1988 160 233 307 186 175 1989 165 225 422 286 212 1990 156 209 524 215 215 1991 169 220 472 NA na 1992 January 180 248 486 NA NA February 170 252 502 NA NA Man:h 195 237 507 NA NA April 180 235 512 NA NA May 180 241 518 NA NA June 180 248 519 NA NA July 180 250 523 NA NA August 180 250 523 NA NA September 205 258 522 NA NA October 205 261 522 NA NA I~ Average offer price for plywood quality logs, FOB Sabah, Malaysia. 1J!Average prices of Meranti, Sa bah SQ best Quality, Sale pnce charged by importers, in Japan. I£ Average weekly pnces, Dark Merantl Select and better quahty, standard densuy, CIF French ports. Source: Nikkei Sangyo Shohin Kenkyu-jo, Nikkei Newsletter on Commodities; Marches Tropicaux ct Mcditerranes; FAO Forest Products Yearbook 1979-1990, 1990 Edition. 5.25. A rough indication for Indonesia can be obtained from a comparison of potential log sale margins with processing margins. A concessionaire could generate a surplus of $60 per cum by selling logs to the international market (at a conservative price of $130 per cum), if the law permitted. The conversion factor for plywood manufacture is 54% (see para 4.38). It is assumed that 1 cum of plywood could be sold for $320- $355 per cum (see para 4.41). If the cost of processing is $145 (see para 4.40) and the mill is able to obtain its log volume for $62 per cum (equivalent to $115 per cum of processed output) then the surplus accruing to the mill lies in the range $60-$95 per cum of output-i.e. $32 - $51 per cum of log volume. 5.26. Clearly, it will be worthwhile on these figures, from the viewpoint of the private sector, to remain involved in processing. This results, however, from the high rents accruing to the private sector from logging: on the basis of the (admittedly approximate) calculations made here, application of capital and technology from that point on does not in fact add value to the resource at all. This suggests that the benefits of employ,ment generation and regional devebt:~ment attributed to processing in Indonesia are presently being attained at high cost. It may be that significant profits are concealed in the costs of manufacturing figures used here, but it seems unlikely this could be so to the extent needed to move surpluses up to the level estimated to be available from log export. These observations provide support for a phased, rather than an 86 immediate, approach to raising rent capture by Government in the forestry sector. Cle:1rly, some time for adjustment in the processing sector will be justified, because structural change is going to be required. Current industry resistance to this will be strong, and a realistic, negotiated time frame to achieve it will achieve the best results. Box 5.1 THE ECONO:MIC COSI' OF PROMOTING VALUE - ADDED PROCESSING IN MALAYSIA A number of southeast Asian countries have used export restrictions to make wood cheap for local processors, and thereby promote local processing, increase value added to wood products, and even discourage logging. Although local processors would in any case enjoy an advantage due to proximity to raw materials (low or no freight charges), protection of domestic processors bas no doubt been successful in increasing the extent of processing and apparent value-added in the processing sector. The questions which need to be asked are: What bas this cost in terms of exports foregone? Has the add1t10oal value-added from processing exceeded this cost? Has the protection created a processing industry which can stand on its own feet, or would it be unable to compete without protection? Experience with export restrictions suggests that the costs of these restrictions frequently exceed the benefits. A World Bank study indicates that the effects in Peninsular Malaysia over two decades were as follows: • Sawnwood production increased by 24 percent with the restrictions, employment increased by about the same amount, and log production was reduced by 15 percent; but, • Without the restrictions, export earnings (from logs and sawnwood only) would have been 22 percent higher, economic value-added 34 percent higher, and resource rent (from harvested logs, and not necessarily captured by the government) 49 percent higher than their actual historical values . . Comparing benefits and costs, each sawmill job created by the log-export restrictions cost Peninsular Malays1a annually M$16,600 in econom~c value-added, M$44,800 in export earnings, and M$92,600 in resource rent. In contrast, the average annual wage in sawmills in 1989 was around M$6,000: There were three additional sources of economic loss to the government. First, the high profits in processing due to depressed log prices attracted excess investment into the industry, causing waste due to overcapacity. Second, mill owners were insulated from the cost pressure that would have induced them to adopt or develop wood- savl.Dg, or market-capturing processing technologies. Third, lower log prices may have discouraged more complete utilization of log input into sawmills. The World Bank's general recommendation for development of wood processing industries bas been to promote it only on the basis of policies which maximize net gains to the national economy by avoiding misguided distortions of incentives. This means: (a) taking excessive profits out of logging by raising royalty rates, and out of pnmary processing by eliminating rebates (if any); and (b) eliminating log export restrictions, but using increased public revenues to overcome limitations of infrastructure, and other facilities which may hold back the development of processing. Source: Thomas Wiens, 1992. "Forest Policy Issues in Southeast Asia. • Paper prepared for the EDI Seminar on "Forestry Management for Sustainable Development. • Genting Highlands, Malaysia, January 26 - February 1, 1992. A development of this analysis has been published by Jeffrey Vincent; • A Simple Non-spatial Modelling Approach to Analyzing a Country's Forest Products Trade Policies" in Proceedings, lOth World Forestry Congress, Paris 1992. 5.27. As noted at the outset of this discussion of economic rent, there is a balance to be struck between Indonesia's desire to remain a large exporter of processed forest output, and the need to price the resource so as to 87 encourage its efficient allocation and thereby, to promote efficient processing. As noted in paragraph 5.2, it is also the case that if log prices are raised precipitously, the temptation to illegally remove timber and/or operate even more carelessly in extraction - so as to maintain profits - will be strong. As discussed in Chapter ill of this report, implementation of improved supervision and enforcee1ent in the forest will not be simple, and it can be expected to take several years to achieve. This adds to the argument for phasing in price rises over time, so that as prices approach high international parity levels, the system for tracking log movements and recovering revenue, are in place. A staged approach as follows is therefore suggested: Phase 1: A statement of intention to raise the IHH + DR total to $32 per cum could be promulgated immediately. The rise could come into effect through application of a production tax, as soon as some initial monitoring and supervision improvements are made (see para 5.2). It might be preferable for the additional tax to be collected as IHH, rather than DR, since the Reforestation Fund, fanned from the DR, is already large (sec para 3.77) and also since the DR was raised recently. Phase II: Further rises could be implemented at regular intervals, so that by some agreed target date (year 2000 would be appropriate, since this is already the year by which Indonesia intends to be in compliance with the ITIO sustainability guidelines), the difference between the domestic IHH +DR average standing timber fee, and that which would apply to a similarly composed group of logs to be sold internationally, is no more than, say, 25%: this would leave some allowance for possible quality differentials in the log mix going to local processing. A pricing formula, allowing for stand quality and locational differentials, should replace production taxes as soon as possible. It may be necessary to release a certain proportion of logs direct to export sale (perhaps through the lnhutani), so as to provide a constant market monitor on international prices. 5.28. The overall revenue implications of revenue rises, especially if combined with more effective enforcement and log tracking, would be significant for the Government of Indonesia. This can be illustrated as follows: Assume that improved enforcement and log tracking enables fees to be collected for 33 million cum of current removals; Assume declines in annual allowable cut to 22 million cum p.a. by year 2000 become necessary to confonn with ITIO guidelines; Assume that fees for standing timber rise immediately to $32/cum; Assume that logging costs (inclusive of profit margin) are $40/cum, and international log prices remain at a (conservative) $130/cum; Assume that the Government targets collection of 75% of this rent by year 2000 and phases in increases sufficient to achieve this target over the 1993-2000 period. Table 5.3 below shows the revenue stream in real terms produced under this scenario: 88 Table 5.3: POTENTIAL REVENUES FROM INCREASED FEES 1993 ~/ Present (following fee Situation increase and 1995 2000 improved Collection) Extraction!Transport ($/m3) 40 40 40 40 International price ($/m3) 130 130 130 130 Implied rent 1! ($/m3) 90 90 90 90 Stending timber fees ($/ml) 20 I£ 32 60 68 Rent collection 22% 35% 67% 75% Volume involved (mm3) 25 33 29 22 Revenue ($m) 500 1056 1740 1496 I Revenue Rp(bn) 1Q 1015 2144 3532 2964 I! At world market price. /Q Constant exchange rate Rp.2030/$. I£ New DR+IHH total per m3 (see paras 5.8 and 5.9). 5.29. To give these figures some perspective: revenues from forestry under this scenario would reach close to 10% of all central Government revenues, and would be approximately equal to present total Government outlays for education in Indonesia. They would amount to fifteen times the current level of annual government expenditure on forest management and development 5.30. One essential requirement in this matter of wood pricing is to give greater public access to the regular process of review of prices. This, in addition to focussing greater public scrutiny on standards of management within the sector, will ultimately assist Government when it seeks to limit the use of forest resources to sustainable levels. Extraction by government of higher rents, and investment of the proceeds in the public good, can be used to offset concerns about lost output if overall volumes are reduced. 89 CHAPTER VI POLICY AND INSTITliTJONAL ISSUES: AN AGENDA FOR REFORM The Motivation for Change in Forestry 6.1. The primary impetus for change in forestry comes from: the broad national economic objectives of the Government of Indonesia, as expressed by the Government; a strong commitment to retain significant areas under forest cover, for environmental and production purposes; and an increased awareness in Indonesia of the need to demonstrate genuinely sustainable management in the natural forest to international purchasers, who are becoming more concerned with this matter. Taken together, these aims place a heavy onus on all parties involved in the forestry sector to work together, plan the changes needed, and ensure that operatives active in the field in the sector adapt to such change. 6.2. There are strong political undercurrents in forestry: these emphasize the urgency of the need for change, but simultaneously raise the risks associated with political and policy reform in the sector. On the one hand, it is becoming increasingly apparent that a certain amount of restiveness in some outer island regions of Indonesia has resulted from the major forest operations which have opened up there. It has been strongly suggested in this review that both local governments, and local communities, will need to receive larger outlays from the proceeds of forest operations, if real progress with sustaining the natural resource is to be made. On the other hand, a forestry extraction and processing sector as economically significant as that of Indonesia automatically accumulates considerable political power. Although a certain amount of dislocation is inevitable when major resource programs are initiated, there eventually comes a point where the costs of social instability must be weighed against those of restraining the vested interests of the extraction and processing establishment. It is apparent that Indonesia now needs to pursue a political consensus in this sector actively. In the final analysis, it may be the need to resolve conflict among the emerging interest groups, rather than specific commitments to environmental goals, which will promote change in the sector. 6.3. In Chapter IV of this review, it was argued that domestic forest sector policies, rather than external trade factors, have primacy in determining the outcome for the forest resources. It has been accepted in this review that the basic objectives of the Government, in committing to specific forest areas for preservation and sustained natural forest production (paras 1.21 to 1.24), and to management of that production forest according to the ITTO Guidelines by 2000 AD, are wonhwhile, acceptable targets. It is argued here that three basic understandings on the part of the Indonesian Government will be necessary to achieve this: (a) Indonesia will need to maintain the political will to resolve the conflicts among interest groups that are apparent in the forestry sector; (b) It will be understood in Indonesia that correct domestic policy settings are vital to progress in the sector, and must be considered as prerequisites to attaining the sectoral objectives discussed above; (c) It will be accepted that, even after policy reform is undertaken, a great deal of institutional and human resource work remains to be done in the sector, to allow implementation of the basic objectives to proceed. 6.4. Since it is policies which will shape the direction and structure of institutions, the policy implications which emerge for the forestry sector from Chapters I to V of this review are discussed below. This is followed by an analysis of the institutional changes such policies might foreshadow. 90 The Policv Agenda 6.5. The major policy issues which have ·arisen in the course of the foregoing Chapters are summarized below, and where appropriate and possible, recommended changes are suggested. 6.6. Resource estimates/forest zoning. Many uncertainties surround the definition and demarcation of forest boundaries and categories in Indonesia. It is apparent that a review of the resource situation in many concessions is necessary. Forthcoming national inventory work will assist, as will development of current government and private sector mapping and remote sensing efforts. In a policy sense, progress with two initiatives already in hand to some extent is important: Improvement or replacement of the TGHK maps and zoning, on the basis of information already available from various public and private sector agencies, is a priority resource management task. Progress with implementation of the KPHP model, or some other mechanism for reviewing and re-zoning concession operation areas and organizing management of these under Provincial units, should be pursued. It will.be important that effective means of building interests and views of the forest dwelling or adjacent communities into re-zoning are implemented. 6. 7. Natural Forest Management and the Concession System. Indonesia's broad objectives in natural forestry management are to retain substantial areas under effective forest cover, and to generate maximum value to the nation in so doing. One broad conclusion which can be drawn from the economic analyses presented in paras 3.10 to 3.24 of this review is that wood production will have to remain a significant element in the mixture- unless major compensatory payments to Indonesia (on grounds of global values) are forthcoming. It is unlikely that this will occur to the extent needed to offset timber values which, in Indonesia's case, are very large: taking the bottom figure ($32/cum) from the range calculated in Chapter V as standing value of the resource, and applying the conservative figure of 25 million cum as an annual output, yields a Government wood revenue figure in the order of $800 million a year to which, if compensation were to be paid for preservation, an even larger amount to cover industry dislocation and losses would nee.i to be added. The figures shown in Tables 3.1 to 3.3 of this review demonstrate that significant global values attach to sustainable management of natural forests and plantation on degraded sites. These values might form the basis of compensatory programs, such as the carbon emission offsets currently being pursued in Malaysia and various South America countries by North American power generating corporations. Such inputs, if they arise, would certainly make sustainable forestry more attractive to Indonesia - but they· would not justify complete preservatiort of the forest resource. 6.8. It is occasionally suggested that debt relief to nations which are heavily exploiting their timber resource (and are carrying heavy debt loadings) may be a m~ns of taking pressure off the resource. However, as has been argued in this review, the origins of unsustainable use of forests are essentially internal, not trade related, and this argument applies equally to the debt relief case. If a country with significant forest resources adopts policies which collect the appropriate economic rents for the resource, and encourage sustainability, then the cause of debt amelioration is served as well as that of sustainability. As a corollary to this: there is no strong evidence to suggest that, even if national debt is reduced, that this in itself will alter forest practices and rates of exploitation. 6.9. The policy issues arising from planning, management, and enforcement in forestry operations have been, and remain, a subject of considerable interest in Indonesia. A great deal of experimentation with new systems - some of it donor supported - is current in Indonesia, and it is prudent not to anticipate results in this area at this stage. It has been pointed out in this review that in recent years, the Ministry of Forestry has upgraded enforcement of concession regulations: a dynamic towards greater compliance is evident, and this should be recognized. Some general observations of a policy nature can, however, be made at _this stage 91 relating to concession conditions, silviculture, monitoring and enforcement, and the value of standing timber. The latter subject is broader than the forest management issue, and is taken up in its own right in paras 6.23 to 6.25 below. 6.10. Alternatives to the concession system are available and operational in many parts of the world, and it bas been argued in this study that these could be applied in renewing or newly opening areas. Where the rights to exploitation of timber have been allocated under the concession system, and where long term rights still apply, there is less scope to fundamentally alter the situation. What can be altered in such cases are the terms under which concessionaires operate, and the effectiveness of supervision and enforcement of those operations in the field. Specific policy changes which could be considered are: The period over which concessions are held should be extended, so that bona fide long term investors in the sector can realize the benefits of good regeneration and management inputs in a second crop. Rather than nominating a specific time frame, a rolling renewal of cutting rights on a periodic basis (probably a 5 year interval) would achieve this incentive, without foregoing Government sovereignty. Although no analysis of the different institutional mechanisms for logging bas .been done in Indonesia, experience from elsewhere suggests that concessionaires should directly manage logging operations on their areas. There would appear to be no reason why such a condition could not be made mandatory at least in negotiation of concession renewals (or issue of new concessions) in Indonesia. The regulatory base for governing forest operations in Indonesia is now complex, and the weight of such regulation may become self-defeating. Streamlining and prioritizing of regulations, so that the field operatives of forestry agencies who must bear the primary burden of enforcement have clear and simple guidelines, is now a priority. Complexity of regulation is compounded in Indonesia by remaining uncertainties in practice as to jurisdiction and responsibilities at Kanwil and Dinas levels. In theory, it would be particularly useful if Kanwil offices, as outposts of the central Ministry, were able to act as centers of policy and regulatory development, and perhaps quality control, while Dinas agencies were mandated (and supported) to execute field responsibilities, and to represent Provincial views in intergovernmental dialogue. A division along. these lines seems to be the intent of current arrangements but, in practice, responsibility and accountability in some areas are not clearly defined, and the result is poor incentive and motivation in control over field operations. Better definition of responsibilities, and a re-ordering of agency funding sufficient to allow all units to carry out their responsibilities, are required. However it is argu~ in this report (see paras 6.67 to 6. 73) that for the medium term at least, measures which go beyond upgrading performance of existing agencies are required: specifically; the introduction of independent inspection and monitoring of forestry field operations. Poor data bases on increment, compartment location, and operations seriously inhibit the application of better forest management. Although silviculture in natural forest management is properly a technical and research issue, it seems that in Indonesia a certain rigidity bas developed, leading to a more automatic application of the 35 year rotation polycyclic TPTI system than the natural variation in forests warrants. The policy implication in this case is that mere authority and flexibility in the application of silvicultural prescriptions should be vested in field level decision makers. 92 6.11. Plantation sector. The basic conclusions of policy interest from this review on the plar.tation sector are: (i) The liTI scheme, which subsidizes pulp and paper investors to establish pulpwood plantations has succeeded on its original terms, in that a number of large pulp and paper invesLors have availed themselves of the scheme, or will soon do so. (ii) Some technical problems in the clearance procedure for the HTI scheme exist, but the larger concerns are: whether the scheme might in some cases be causing clearing of areas potentially regenerable as natural forest; and whether adequate measures will be taken to prevent use of potentially regenerable natural forest for pulpwood supply. 6.12. The concern noted in (ii) above needs to be kept in some perspective. It is unlikely that more than 1.2 m ha of land will actually be utilized for pulpwood planting in Indonesia. The practice of using liTI hinterland areas as tropical moist forest pulpwood supply zones should cease immediately. Also, measures to ensure tha• areas selected for pulpwood supply are not those effectively returning to productive natural forest condition, and measures to encourage plantation on open, degraded sites, should be implemented. Government assistance for plantation activity should be redirected to investors willing to establish plantation on open, significantly degraded sites such as alang-alang. Non-HPH investors, including secondary wood processors, sawmillers, local community groups, and, if appropriate, Provincial governments, should be approached as possible recipients alongside HPH holders willing to invest. Whether subsidies are justified, under such circumstances, is a debatable point: other means of assistance - the guarantee of tenure, research into tree breeding, and other public good elements of plantation - should be offered first. Government must ensure that long tenure on such sites is guaranteed: the community issues (see para 6.13) will be important in this respect. Given the commitment to sustainable forest management, it must be made clear that HI1 schemes which place at risk significant areas of potentially regenerable natural forest are unacceptable. In this vein, withdrawal of exceptions such as appears to be the case in Ministerial Decree (442/92) to the general requirements for HTI is indicated, and review of whether the requirements themselves are sufficiently rigorous, are also necessary. 6.13. Forest dwelling/Adjacent communities. Information and impressions gathered during the course of the Sector Review Mission indicate that there are substantial numbers of people who depend in some significant way on forested areas for their livelihood. Although no precise estimates can be made, it seems apparent that significant numbers of people have been displaced or disturbed in some way by forest operations. While DBMT and Ministry of Forestry initiatives which address this issue in a generic or specific way have been implemented, it is reasonable to suggest that, so far, these have encountered only limited success. Considerably more thought needs to be devoted to finding equitable and acceptable means for involving local communities in official forest land use programs. Given the complexity of this matter, and the dearth of accurate information about it, it is unlikely that any single policy set and modus operandi will apply in all cases. 6.14. Policy determination and implementation in specific cases would be greatly assisted by the of availability accurate data on the spatial and demographic dimensions of forest dwelling and forest dependent communities. This data could be accumulated and analyzed through: • A human resources inventory gathering demographic data on all forest-dependent communities; 93 • Micro-economic and anthropolo~cal rapid rural studies of existing community-based forest management institutions; • Pilot programs in community-based forest resource management; • Forest mapping exercises showing the territorial extent of indigenous and migrant communities and their territorial relationships with Ministry of Forestry forest categories. 6.15. The intent of recent legislation (discussed in paras 3.126- 3.128, and Annex 4) and high level Government policy statements in Indonesia is to involve forest adjacent communities in land use decision- making and management of forest resources. Although the Ministry of Forestry has jurisdiction in forested areas, it is not an untrammeled power .and is not intended to eliminate customary claims. Now is the time to operationalize the recent legislative and policy initiatives, including use and strengthening of AMDAL provisions for consultation. Forestry agencies and private sector forestry operators would be well advised to be more proactive in the search to identify and positively involve affected community interests in forest operations. Administrative guidelines and an operational manual for programs dealing with forest-dwelling communities should be developed. 6.16. These guidelines should include procedures for timber concessions which, inter alia: • Mandate that an applicant for a timber concession, industrial tree plantation, or other commercial forest-based enterprise must provide indigenous forest-dwelling communities with notice of their intent to file an application; • Provide communiti~ with an opportunity to review and comment on the proposed activity; • Provide communities (especially those with .a long-standing land use claim) with an opportunity to negotiate a joint management agreement monitored by relevant governmental and non- governmental organizations; and • Provide communities who do not negotiate a joint management agreement with adequate compensation arrangements monitored by relevant governmental and non-governmental organizations. 6.17. Those responsible for decisions on forest operations must also take responsibility for what occurs after logging, in general. Regional planning, management, and dispute resolution mechanisms should address these concerns and involve all interested parties (e.g. Government, concessionaires, communities). 6.18. Local communities require funding to facilitate their involvement in forest management. A mechanism to accumulate such funding and to allocate it among affected groups, or to agencies capable of working with them on the generation of useful and sustainable investment proposals, should be developed. Such a fund could be created from (enhanced) royalty collection (see paras 6.23 to 6.25). Paras 6.77 to 6.80 below discuss possible disbursement mechanisms. 6.19. Trade and forest industries. The international markets into which Indonesia will wish to sell its forest products appear to offer prospects of steady growth. Indonesia's share of these markets will, however, depend on its success in producing demonstrable progress towards sustainability, and upon internal development of efficiency and competitiveness in processing. 6.20. This represents an altered policy situation for Indonesia. Major trade and industry policies enacted in the sector in the past decad~ - the log export ban, and high taxes on sawn exports - have been 94 aimed at raising the level of domestic value added in the sector, and, by this broad criterion, they have succeeded. Moreover, it should be acknowledged that some of the reasoning originally advanced in favor of banning log exports had logic: for example the need, in a business and-marketing sense, to create a large, unified processed product supplier, to overcome some barriers to entry of processed forest products in major consumer nations, and to carry sufficient weight to maintain pursuit of market share. Whilst this kind of argument finds limited support in classical trade theory, it is more appealing to those who need to be persuaded to mobilize investment capital in the sector. However, the era during which the processing sector was expanded rapidly is now largely in the past: diversification, consolidation and development of efficiency and competitiveness should now be the goals of policy in this sector. One means of generating competitive pressure in the sector would be to re-open the log market to exports, so that local processors would be forced to pay international prices for their log supplies. It is likely that such a move, if introduced summarily, would be highly disruptive and politically unpopular in Indonesia. Even a restructuring of log export taxes to allow limited export of raw material would still be extremely difficult politically to introduce in Indonesia. 6.21. The next best solution, and the one recommended in this review, is to retain the log export taxes intac: for the present, but to implement a schedule of domestic log price rises so that, eventually, local processors are paying something close to international parity prices. This would retain the psycholological value of the taxes, in vie":' of the perceived increasing scarcity of the raw material resource and the need for local investors to know that it will be available to them in the longer term. But over time it would reduce the cost of the policy, in terms of economic rent foregone, to the resource owners. Provided it is done over a reasonable time frame, but on the basis of a clear policy statement by Government, it would allow time for the sector to adjust to a more competitive pricing regime, and provide the necessary incentive for structural change to occur. 6.22. That such adjustment is needed emerges fairly clearly from the information and analyses put forward in this review: The plywood industry holds a favored position in the forestry sector of Indonesia, largely through the strong linkage between forestry concessions and plywood operations. This linkage is a deliberate act of Government policy, intended to encourage a long term approach to the resource by constraining its use to processors who have made major investments and are therefore expected to have a long term view. However, given that large rents accrue to the private sector in logging operations, whereas the margins in processing are decidedly more risky, the effect of this nexus appears to have been to encourage a view of the plywood industry as a means of legitimizing access to excess rents in logging, rather than a profit maximizing processing sector in its own right. This leads to a lack of innovation in plywood processing (for example, towards production and marketing of consumer grade decorative plys, instead of heavy reliance on relatively low value commodity grade material). It will also discourage investment by plywood manufacturers in replacement of the natural resource with plantation material, unless subsidies are paid. The most obvious and immediate measure the Government could take, under these circumstances, would be to enact standing timber pricing policies designed to extract the maximum rental for the logs, so that processors who remain active in the sector will be those capable of competing internationally without benefit of a large implicit raw material subsidy. Some observations were made in this review as to the role of APKINDO in setting marketing policy and strategy in plywood. No judgement is made here as to the overall effect of the organization in the past, beyond the observation that it bas had a central role in the creation of the sector. A policy issue arises for Government, in that, if the plywood sector is to diversify in Indonesia under the impetus of log pricing and international market developments, some plywood manufacturers may be ready to operate independently of the Association. On the one hand, if this is allowed to occur, the Government los-es a powerful potential ally for imposing 95 discipline on the sector, since the .Association would lose its veto over export licensing under such circumstances. On the other band, more freedom in the trade and marketing area, coupled with efficiency incentives in the raw material area, might stimulate more vigour in the sector. The sawmilling sector in Indonesia was not particularly efficient prior to imposition of high sawn export taxes. Since then, capacity utilization and productivity appear to have declined, although the industry still bas protected access to the domestic Indonesian market. One of the_ major reasons given in support of the sawn export tax policy was to generate higher value added by forcing more log volume into secondary wood processing in Indonesia; and, in the process, to curb the practice of export of very large sized sawn material (i.e. relatively unprocessed material) largely as a means of avoiding the log export ba~. However, there is some indication that the viability of that secondary processing sector is dependent upon the health of the sawmilling sector. A shift in the export tax policy, to some sort of sliding scale (based on sawn sizes, or unit f.o.b value of the product to be exported) would allow the Government to retain the effective prohibition ori export of very large sized material - by applying high taxes to such material - but would encourage sawmillers producing more valuable products (and sawmills are capable of producing sawn and dressed products which are certainly of equal value to plywood) to export. The above measure may, or may not, in itself, stimulate the secondary wood processing sector in Indonesia. Some secondary processors (and potential investors in that sector) who responded to inquiries by the Sector Review Mission claimed that their principal problem was a lack of guaranteed access to logs in Indonesia: a problem exacerbated by the apparent unwillingness of the Investment Coordinating Board (BPKM) to approve investments in such capacity without evidence of supply. Thus, after an initial surge, investment in this sector now appears to be stagnating in Indonesia. While nothing can be deduced from material gathered for this review about the likely international competitiveness of the secondary wood processing sector, it is clear that its capacity to generate employment and regional income are higher, per cubic meter of log input, than either plywood manufacture or sawmilling in Indonesia. Assuming that Indonesia chose to alter the export tax structure for sawn timber as discussed above, and possibly to relax BPKM constraints on investment in secondary processing, the evolution of all processing sectors reliant on natural forest raw material would then depend on access to raw material. Some indication of current status in access is given by the capacity utilization figures shown for the various subsectors in this review: essentially, the plywood sector is operating at near full capacity (some constraint on expansion of capacity has been applied by the industry association); the sawmilling and secondary processing sectors are operating well below capacity. 6.23. The central role of standing timber prices. It has been a central argument of this review that the mechanism of standing timber price determination is critical both to in-forest management and utilization, and to the structure and efficiency of the processing sector. It is recognized that simply raising prices for revenue purposes, without improving supervision and monitoring capacity, would probably not have the desired efficiency effects. 6.24. Even though the natural standing timber fee has been raised from $15 to around US$22 per cum in Indonesia, it is still too low. This price undervalues the resource, and encourages waste. It allows only very limited competitive bidding among processors for the resource - even though wood raw material is the scarce resource - because price does not take any allocative role in disposition of the r-~