Public Disclosure Authorized

ReportNo. 8317-IND

Indonesia
TradePolicyReport

March22, 1991
CountryDepartmentV
AsiaRegion
Public Disclosure Authorized

FOR OFFICIALUSEONLY
Public Disclosure Authorized

)
Public Disclosure Authorized

'J1

Thisdocument hasa restricted andmaybeusedbyxecipients

distribution
maynototherwise
of theirofficialduties.ft~contents
-onlyin theperformance
be disclosedwithoutWorldBankauthorization.
 CURRENCYEQUIVALENTS

Before November 15, 1978 US$1.00 = Rp. 415

Annual Average 1979-89

1979 US$1.00 = Rp. 623

1980 US$1.00 = Rp. 627
1981 US$1.00 = Rp. 632
1982 US$1.00 = Rp. 661
1983 US$1.00 = Rp. 909
1984 US$1.00 = Rp. 1,026 /a
1985 US$1.00 - Rp. 1,111
1986 US$1.00 - Rp. 1,283 Lb
1987 US$1.00 = Rp. 1,644
1988 US$1.00 - Rp. 1,681
1989 US$1.00 = Rp. 1,770

December 1. 1990 US$1.00 - Rp. 1,884

FISCAL YEAR

Government - April 1 to March 31

Bank Indonesia - April 1 to March 31
State Banks - Janurry 1 to December 31

/a On March 30, 1983 the Rupiah was devalued from US$1.00 = Rp. 703 to
US$1.00 = Rp. 970.

/b On September 12, 1986 the Rupiah was devalued from US$1.00 = Rp. 1,134
to US$1.00 - Rp. 1,644.

1
 FOR OFFICIAL USE ONLY
TRADEPOLICYREPORTON INDONESIA

Table of Contonts

Page No.

SUMMARY AND CONCLUSION........ ...... ........ v-xiiiJ

CHAPTER 1 - TRADE POLICY REFORH AND ECONOMIC ADJUSTMENT ............... 1

A. Introduction ...................
. ........ ...................
*
B. MacroeconomicDevelopmentsand Trade Policy Reform ........5
C. The Changing Pattern of Incentives ........................
5
D. The Effects of Policy Reform ........ . 19

CHAPTER 2 - THE CURRENT TRADE REGIME . ........................... 31

A. Introduction..............................................
31
B. The Import Regime .. 32
C. The Export Regime .. 41
D. The Current Pattern of Incentives .........................53

CHAPTER3 - FFFECTS OF THE TRADEREGIMEON SELECTED

MANUFACTURINGACTIVITIES ..................................
57

A. Introduction 57
..............................................
B. Textiles ..................................................
59
C. Steel .....................................................
68
D. Footwear ..................................................
73
E. Paper .....................................................79

CHAPTER4 - EFFECTS OF THE TRADEREGIMEON SELECTED

AGRICULTURAL ACTIVITIES ...................................
83

A Introduction ..............................................
83
B. Agricultural Imports and the Trade Regime .................
84
C. Agricultural Exports and the Trade Regime .................
90
D. Case Study: ProcessedFood Products...................... 93

CHAPTER 5 - A POLICY FRAMEWORKFOR FUTURE REFORM . ..............

105

A. The General Objectivesof Reform.........................

105
B. Non-TariffBarriers to Imports...........................
107
C. Tariff Reform ............................................
111
D. The Export Regime........................................
119

The report was preparedby a team led by John Wilton (RSI-Jakarta).

The other principalcontributorswere R. Chapman,J. Coyle, G. Fane, D. Pearce
(Consultants). Other contributorswere J.M. Doublet (YP), G. Walton
(Consultant)and Y. Hamid (ResearchOfficer). The report was written prior to
the announcementof the May 1990 trade policy reforms. As such, the
implicationsof these new reforms are not reflected in this report.

This document has a restricteddistributionand may be used by recipientsonly in the performance

of their officialduties. Its contents may not otherwisebe disclosedwithoutWorldBank authorization.
 - ii -

TEXT TABLES

Table No.

Chapter 1

Page No.

1.1 Impact of Reform Packageson Import

Licensing Coverage since 1906 ......... ...... .. ..... 9
1.2 Changes in the TaLiff Schedulefor
the WholeEconomy since 1985 ............. ...... ...... . 10
1.3 Implementationof BAPEKSTA Scheme ....................... ......
13
1.4 Manufactur4ng Exportsunder BAPEKSTA . .............. , 4
1.5 Main Items Importedunder BAPEKSTA'sDuty Exemption Scheme,
May 1986-June 1989.............. .......... ....... *.... 15
1.6 Export Loans Outstanding, 1985-89 ................ 16
..............
1.7 LendingRates at Deposit Money Barks ................
.........o 17
1.8 Change in Wholesale Price of Exports Relative to Imports,
1986-1988 ..... .. . ..........
....... ..
.. . ....... .19
1.9 Impact of Policy Reforms .. ...................... *.20
*............

1.10 Macroeconomic Efficiency Indicators . ............. 21

1.11 Private InvestmentApprovals by BKPM, 1983-1989..... o ..........
23
1.12 Trends in Real Rupiah Wages, 1981-1988...........
........... 24
1.13 Growth in Importsby Broad Ecc,nomicCategory, 1983-1988 ........24
1.14 Growth in Exports, 1983-1988 ...... . ..... 26
1.15 Export/GDP Ratios, 1980-88s Selected Countries .................27
1.16 Growth in Value Added and Employmentin Large and Medium
Manufacturing .............................
............
* .......28

Chapter 2

2.1 Distributionof ProductsIncluded in the Restricted

Goods List, by License Type and Sector .........................
33
2.2 Distributionof 'PI' License Items by Importerand Product .....36
2.3 The Indonesian Tariff Schedule at a Glance .................... 38
2.4 1989 HarmonizedTariff Schedule,Average Tariff
Plus Surcharge Rates ... . .
................... .. .39
2.5 Incidenceof Surchargesand Splits . . . 40
2.6 Export Restrictions. ..
.... . .....................................
43
2.7 The Pattern of Incentivesin 1988................. .......
55

Chapter 3

3.1 Output and Employmentin the Textile Sector, 1975-1988 .........61

3.2 Export Performanceof TextilesSector, 1975-1938............... 62
3.3 Import Performanceof TextilesSector, 1975-1988 ..............62
3.4 Sources of Groth in the TextilesSector:
Production, Trade and Consumption . ............ .....63
3.5 65
Textile Quota Utilization Ratios ...........................................
3.6 Output Growth in the Steel Industry,1983-1986 .................
68
3.7 Ratio of Imports and Exports to Domestic Steel Production......
69
 - iii -

3.8 Coverageof Export License Restrictions- Selected

Basic Steel and Steel Products, 1986-1988 ......................
71
3.9 Import Regulations,Tariffs and Performance,
Selected Steel Products . ... .. ....................... 72
3.10 Average Tariff Rates - Basic Iron and Steel and
Other Metal Products, 1985-1989 ............... ................72
3.11 FootweartGrowth in Output, Exports and Imports,1983-1988 .....74
3.12 ChangingExport Markets for Leading Indonesian
Footwear
Exports, 1986-1988. ..... .... ............... . .75
3.13 Leather Importsby Indonesia,1983-1988 .76
3.14 Average FootwearTariff Rates, 1985-1989 ....
3.15 Paper and Paper Products:Output, 1983-1988 .. 79
3.16 Paper and Paper Products:Exports and Imports,1983-1988 .......
80
3.17 Tariff and Surcharges:Major Paper and Paper-ProductsItems,
1983-1989 ............................. e
3.18 Tariffs:Major Paper-MakingMaterials,1985-1989 ...............
82

Chapter 4

4.1 AgriculturalImports by Commodity,1983-1988 ...................

85
4.2 ComparativeReturns to FoodcropProduction,1987 ...............
87
4.3 AgriculturalExports by Commodity,1983-1988 ...................
91

Chapter 5

5.1 Effects of ProposedReform Program on Unweighted

Average Tariffs ...... .. .. .114

Graphs/Boxes

Chapter 1

Graph 1.1 Real EffectiveExchangeRate, International

Competitiveness ....................................... 7
Graph 1.2 Traded vs Non-Traded Goods Prices ........................ 7

Chapter 2

Box 2.1 Effect cf an Export Ban . ...

Chapter 4

Box 4.1 Allocationof Coffee Quotas .. 97

Box 4.2 The Marketing of Nutmeg. 10
Box 4.3 Longer Term Effects of Export Restrictionson
..
Agricultural Commodities ...................... ........ 102

Chapter 5

Graph 5.1 Share of Consumptionand Import Taxes in Total

Government Revenue . .............. .. ....... . 118
 SUMMARY AND CONCLUSIONS

Trade Policy Reform and EconomicAdjustment

(i) Indonesia'strade policy strategyhas changed significantly

during the 1980s. At the start of the decade the trade regime was
inward-oriented, promoting investmentby both the public and private sector in
highly protectedactivitiesgeared towards supplyingthe domesticmarket.
Initiallythe primary instrumentof protectionwas a high and disparate tariff
structure. From 1982, the steady weakening in the prices of Indonesia's
commodityexports (particularlyoil) and the adverse effects of the world
recession,resultedin slower economicgrowth. While the Governmentresponded
appropriatelyat the macrc;economiclevel, by promptly implementinga
stabilizationprogram desigr.edto reestablishfinancial stability (1982-85),
the trade regime became more inward-oriented. Faced with slower growth in
domestic activityand many manufacturingplants carryingexcess capacity, Ff
tariff protectionwas supplementedby a proliferationof non-tariffbarriers
(NTBs) in the form of restrictivelicenses. Although the Governmentdid
implementa comprehensivereform of the tariff structurein early 1985, the
beneficialeffects of this reform were significantlyreducedby the
introductionof many specificduties and the increaseduse of NTBs. By the
end of 1985, more than 1,700 tariff positionswere subject to import licensing
accountingfor over 401 of both import value and traded domesticproduction.
In addition,export restrictionsin the form of bans, taxes and quotas became
more commor.nlace- particularlyfor unprocessedagriculturalcommodities.
Thus, while short-termmacroeconomicstabilitywas restoredby 1985, other
medium-term structuralproblems in the economyhad not been adequately
addressed.

(ii) The collapsein oil prices in early 1986, and the forecastof
continued slow domesticgrowth, encouragedGOI to reassessthis strategy. The
rapid decline in oil-relatedtax revenueand export earnings further curtailed
the Government'scapacityto financeplanned levels of public expenditureand
underlinedthe danger of fosteringa 'high cost' domesticmanufacturingsector
that was uncompetitiveon the world market. In response,the Government
implementeda series of 'deregulationpackages"aimed at increasingprivate
sector activity and stimulatingnon-oil exports. A key componentof these
packages has been several trade reform measuresdesignedto improve the
internationalcompetitivenessof the economy and reduce the overall bias
against trade.l/ The primary focus of the trade reformshas been to move away
from a trade regime based upon non-tariffbarrierstowards a less distorted
regime based on import tariffe and to provide exporterswith access to
imported inputs at world prices. Prior to the May 1990 reforms,about half of
the restrictiveimport licenseshad been removed,loweringthe NTB coverageof
total domesticproductionfrom 41? in 1986 to 29? by end 1988. Also, in 1987
the need to obtain an export licensewas abolishedwhich opened trade to all
holders of a business license,except those goods under special export
regulations. These measures occurredwithin the context of a second
macroeconomicstabilizationprogram (1986-88),designedto reduce the external
and internaldeficitswhich had occurredin the wake of the further decline in
oil prices and the adverse effects of currencymovements on debt payments.

1/ Since this reportwas preparedbefore the May 1990 reforms,the

analysispresentedhere does not reflect the implicationsof these new
 - vi -

(iii) The Changing Pattern of Incentives. The rapid and sustained

deteriorationin Indonesia'sterms of trade from 1986, coupled with
"high-cost"local industries,necessitateddomestic relativeprices to adjust
in two ways. First, the price of tradablesneeded to rise relativeto the
price of non-tradables- both to encouragedomestic resourcesto switch into
the productionof tradablegoods and to reduce the domestic demand for
tradablegoods. Second, the price of exportablesneeded to rise relativeto
the price of importables- to further encourageresourcesto move into the
productionof non-oil exports and to increasethe pressure on import
substitutionactivitiesto become more competitive.

(iv) Severalmeasures or proxies for the pattern of incentives

prevalent in Indonesia since 1985 indicatethat the Government'sadjustment
program is having the desired effect. First, the 312 nominal devaluationof
the exchange rate has been supportedby appropriatemonetary and fiscal
policies designed to contain inflationarypressuresand therebymaintain the
gains in internationalcompetitiveness. The resultingchange in the real
exchange rate has lowered real wages in Indonesiarelativeto competitive
countriesand raised the domesticprice of tradablesrelative to non-
tradables. Second, the cumulativeimpact of the trade reform packages
announcedsince October 1986 has resultedin the removal of 839 items from
license control,accountingfor 482 of all items and 522 of the total import
value previouslyrestricted. More importantly,the share of total domestic
productionprotectedby NTBs has declinedby about a third, with most of the
reductionbeing concentratedin the manufacturingsector where nominal and
effectiverates of protectionare highest. The removal of NTBs has
reestablisheda direct link between domesticand world prices, and created a
trade regime which will allow the level and variance in protectionto be
lowered over time (i.e.,by adjusting the nominal tariff). The substitution
of tariffs for NTBs has resultedin a decline in the price of imports relative
to exports and provided domesticusers of importedmaterials more certainty in
terms of deliverytimes and quality.

(v) A third change in the pattern of incentivesoccurred in 1985 as

a result of the aforementionedacross-the-boardreductionin tariff rates.
The tariff ceilingwas lowered from 225X to 602 (witha few exceptions)and
the number of tariff rates were reduced from 25 to 11. This lead to a decline
in the averageweighted import tariff from 222 to 132 by import value or from
292 to 192 by domesticproductionvalue. Sir.ce1985, the tariff schedulehas
been subjectto a number of ad hoc changesprimarily associatedwith the
deregulationpackages. The overall effect of these changes has been a gradual
decline in the variance of tariff rates (from 108 to 84) with little impact on
the overall average tariff rate. The one major recent improvementin the
tariff structurewas the reductionin the number of items with specificduties
from 498 to 19 items. This occuredwhen GOI convertedto the new Harmonized
System (HS) of classifyingtraded goods. However, the positive effects of
this reform have been offset by the recent proliferationsof import tariff

;
 - vii -

surcharEesand split-tariffpositions.l/ These have been used as a mechanism

to target assistanceto particularproducersor goods.

(vi) Fourth, export incentiveshave been improvedby the creationof

the duty exemption and drawback scheme (BAPEKSTA)in May 1986, and the
provision of subsidizedexport credit/insurancesince 1982. The BAPEKSTA
facilityhas worked extremelywell, expandingrapidly to cover about 24Z of
total manufacturednon-oil exports by 1988. The scheme has providedmany of
the fast growing 'emerging'sectorswith importedinputs at world prices, such
as food products, footwear,rubber and wood products,and textilesand
garments. Aside from price considerations,firm level interviewsconfirmed
that BAPEKSTA is importantbecause it ensures access to good quality and
uniform inputs and because it increasescompetitivepressures on potential
domestic input suppliers. The provisionof subsidizedshort-termexport
financing,pre-shipmentexport financeguarantees (PEFG),and export credit
insurance/guarantees (ECIIG),were announcedin January 1982. There has been
a very rapid increase in officialexport financingand (the obligatory)PEFG,
reflectingthe recent surge in non-oil exports. Subsidizedexport loans have
grown faster than other broad measuresof credit,with most loans going to t t
manufacturingand trade sectors. Since Indonesia'saccession to the GATT Code
on Subsidiesand CountervailingDuties in February 1985, interest rates have
been increasedfrom 92 (primarygoods) and 6X (non-primarygoods) to 142 and
14.5Z respectively. While current rates are positivein real terms, they are
substantiallybelow prevailingcommercialrates.

(vii) Finally, the costs of processinggoods through Indonesianports

(exportsand imports)and maritime transporthave been significantlyreduced
by recent policy reforms. During the 19809 the port clearanceand transport
sector became highly regulatedwith controlson tariffs, licenseson routes
and a range of other permits. This caused serious delays, restrictednew
private investmentin the sector and raised the costs of internationaltrade.
An importantstep towards addressingthese problemswas taken in 1985 when the
Governmentreplacedthe public customs servicewith a private sector
organization(SGS),21 restructuredport operationsand partially deregulated
internationalshipping. This resulted in cargo clearance and ship turnaround
times falling dramatically,freight rates declining,and an improvementin the
quality and reliabilityof serviceto shippersand consignees. The Government
moved further in 1988, wben it introduceda sweepingrange of reforms designed
to deregulateinternationaland national shipping. An initial assessmentof
this latter reform would indicatethat Indonesianow has a more open and
unregulatedshippingindustrythan most other maritimenations. As a result,
over 40 new shippingcompanieshave been licensed,with a corresponding
increasein price competition.

1/ A split-tariffposition is the subdivisionof a standardnine digit

HarmonizedSystem product description,into finer product descriptions.
It is used to provide differentimport tariff rates or import license
protectionfor similar products- dependingprimarilyon whether the
specificproduct is produceddomesticallyor not.

2/ SocietieGeneralede SurveillanceS.A., a Swiss based private company.

 - viii -

(viii) The Effects of Policy Reform. At the macroeconomirlevel, the

economy has respondedstronglyto the government'sbalanced adjustment
program. Since 1982, both the current account and budget deficit have been
containedat managable levels, inflationhas been reduced and economicgrowth
has been maintained. Indeed, there is mounting evidencethat the economy has
been growing at a faster pace than previouslyestimated,particularlysince
1986. This strong performarcehas enable GOI to substantiallyreduce the
incidenceof poverty at the same time as undertakingthe necessarymeasures to
adjust the economy to the large external shocks experiencedthroughoutthe
1980s.3/

(ix) During the initial stabilizationphase (1982-85)the current

account deficit was quickly brought down through a combinationof appropriate
macroeconomicmeasures (i.e., adjustingthe exchange rate, reorderingpublic
expenditurepriorities,reducingexpenditntre levels) combinedwith a less
appropriatetighteningof import controls (i.e., a proliferationof NTBs). In
the second stabilizationphase (1986-88)most of the adjustmentin the
externalaccount derived rrom the rapid growth in non-oil exports,which
increased from US$6.7 billion in 1986/87 to an estimatedUS$12.1 billion in
1988/89. In contrast to the first stabilizationperiod, imports also grew by
5.8Z p.a. between 1986/87 and 1988/89 - reflectingthe relaxationof trade
restrictions.

(x) As noted in the latest EconomicReport on Indonesia,the

Government'sfiscal and monetarymanagementhas been at the center of
Indonesia'ssuccess in reducinginternalimbalancesand containinginflation.
A major tax reform, expenditurerestraint,and tight monetarypolicy have
reduced the budget deficit to a manageablelevel and contained inflationbelow
10% since 1985. This in turn has preservedthe competitiveadvantaged
provided by the change in nominal exchangerate.

(xi) The trend in both.private sector investmentand macroeconomic

efficiencyindicatorsdiffer markedlybetween the two stabilizationperiods.
In the initial adjustmentphase, private investmentdeclined due to higher
real interestrates and lower aggregatedomestic demand. Since 1986, private
investmenthas recovered,respondingto the improved incentiveand regulatory
frameworkcreated by the post-1985reforms and the resultinghigher level of
economicactivity. Much of this new investmenthas been directedtowards
export activities. Indicatorsof macroeconomicefficieacymirror this
pattern,with both the average rate of return on investmentand total factor
productivityimprovingmarkedly in the period 1986-88 relative to 1982-85.
The accelerationin economicactivity is also reflectedin the recent surge in
private investmentapprovals issued by the InvestmentAuthority (BRPM).
Domestic investmentapprovals rose by 1342 in 1987 and 45Z in 1988, and
foreign investmentapprovals rose in US dollar terms by 762 in 1987 and a
remarkable3002 in 1988 to US$4.4 billion. While this increase in private
sector activity is an extremely encouraging sign it should be noted that
realizationof these investmentsis laggingbehind approvals. This is partly
due to the remainingcomplexitiesand weaknessesof the domesticregulatory

3/ For an assessmentof the incidenceof poverty during the 1980s, see,

"Indonesia- Poverty Assessmentand StrategyReport",World Bank
report - Green Cover.
 - ix -

framework.It is also not clear that all this new investmentis being
channelledinto areas where Indonesiahas a clear comparativeadvantage due
partly to remainingdistortionsin the trade regime. Both of these ca.-eats
world argue for an accelerationof the pace of reform to hasten the
realizationof planned investmentand to ensure that new productivecapacity
is created in areas where Indonesiacan compete on world markets.

(xii) The trend in imports reflectsthe changes in incentivesoutlirned

above. From 1983-86 importsdeclinedby 12.52 p.a. in constantprices, as a
result of the devaluation,the general slowdownin economic activityand the
increaseduse of import licensingrestrictions. Since 1986, the recoveryof
private investmentand partial deregulationof imports has been accompaniedby
a 6.6Z and 4.62 p.a. real growth in capital and intermediarygoods imports
respectively. It is noteworthythat most of the trade deregulationto date
has focussedon loweringthe price of capital and intermediategoods and
improvingthe access of expc.tersto importedinputs. By contrastthe
continueddecline of consumergoods imports since 1986 (-3.9? p.a. 1986-1988),
reflectsboth the decline in real purchasingpower due to the oil shock and
the fact that this is the area in which there has been the least deregulation.

(xiii) The most strikingfeature of Indonesia'ssuccessfuleconomic

adjustmenthas been the growth of non-oil exports,which increasedfrom
US$3.9 billion in 1982/93 to US$12.1 billion in 1988/89. This growth has more
than offset the decline in oil and LNG export earnings,resulting in the share
of non-oil exports in total exports rising from 21? in 1982193 to 61? in
1988/89. This strong performancehas been primarily based on the rapid
--oansion in manufacturedexports. While textilesand plywood providedmost
'fthe gains in the first stabilizationperiod, the wide range of products
classifiedunder 'other'manufacturedgoods has taken the lead since 1986.
For example, dollar export earningsfrom plastics,ceramics, glass, basic
metal products, footwear,furniture,paper ar.drubber products,have all grown
by more than 80? per annum since '985. Two recent econometricstudies
indicatethat the strong growth in non-oil exports during the second
adjustmentperiod cannot be fully explainedby the change in the real exchange
rate, and that improvementsin the trade and domesticregulatoryframework
have contributedto this performance. These reforms have led to an increase
in capacity utilizationin export crientedindustriescoupledwith, as noted
above, a surge in private domesticand foreign investment. It is alsn
importantto note that despite this strong export performance,Indonesia still
accounts for a small share of most world markets. Althoughmanufactureshave
been the most rapidly growing component,Indonesia'sshare in world exports of
manufacturesis estimatedat 0.4? in 1987 (comparedwith 0.1X in 1980).

(xiv) Finally,another importantfinding is that deregulationhas

coincidedwith a strong surge in manufacturingemployment. Preliminarydata
on the growth and compositionof the manufacturingsector, indicatethat not
only has the rate of growth in value added increased (from 15.0? p.a. during
the period 1982-85 to 18.32 p.a. during 1986-88),but that the growth in
employmentacceleratedfrom 5.1? p.a. to 9.1? p.a. over the same periods. The
strong growth in employmentreflectsa switch in resourcesduring the second
stabilizationperiod, both between and within sectors,towards those
relativelylabor intensiveactivitiesin which Indonesiais internationally
competitive.
 - x-

The Current Trade Regime

(xv) Despite the progressnoted above, Indonesia'strade regime still

hatnpetsthe efficient allocationand use of resourcesas well as taxing
domestic consumers. Due primarily to the effects of the import regime, the
pattern of trade incentivescontinuesto provide high protectionto
manufacturingrelativeto agricultureand favors productionfor the domestic
market over exports. And, althoughthe aforementionedexporc assistance
measures reduce the overall anti-exportbias of the trade regime, their effect
is partial, leavingmany potential economicactivitiesand the losses incurred
by consumersuntouched.

(xvi) With respect to the import regime, two policy instruments

dominate:-the RestrictedGoods List and the import tariff structure. The
Restr4 cted Goods List, limits the right to import listed commoditiesto
hold rs of a particulartype of license,thereby creatinga non-tariffbarrier
(NTB) to trade. There are about 900 items on the RestrictedGoods List,
accountingfor about 212 of total import value and, more importantly,292 of
total domesticproduction. Aside from import bans, there are basically four
types of import licenise under which restrictedgoods can be classified.4/ The
degree to which these differentlicense categoriesrestrict trade (i.e., the
height of the NTB) varies significantly.

(xvii) The least restrictiveimport license category is the IP license

(105 items). This is availableto those domesticproducerswho use IP items
as inputs into their productionprocess. The IP categorycovers a range of
mechanicaland electricalgoods in their completelyknocked-downcondition
(CKD Kits), as well as some textilesand steel items. The overall intention
of the IP license is to encouragedomesticproductionof the listed item
(e.g., fabric or diesel engines)at the same time as allowing some downstream
users (e.g., garment or motorcarproducers)access to importedinputs. Aside
from raising the cost of restricteditems to domesticconsumers,the IP
license increasesuncertaintyfor downstreamusers due to the administrative
discretioninvolvedin determiningboth access to the IP license and the
inputs producerswill be allowed to import.

(xviii) The AT license (70 items) is used exclusivelyfor engineering

and transportequipment in its completelybuilt-up (CBU) form. AT items are
restrictedto a few designatedforeign suppliers. The Government'sintention
is to encourage these suppliersto make a long-termcommitmentto provide
back-up servicesand/or establishassemblyplants in Indonesia. Although this
policy may yield some benefits in terms of standardizingspare part and
maintenanceneeds, the absence of open competitionimposes costs in terms of
higher prices and limited choice. Import bans (18 items) are used to further

4/ These are IP (ImporterProducer);AT (Agent Trader);IT (Importer

Trader); and PI (ProducerImporter). For a detaileddescriptionof
these license typcs see Chapter 2.
 - xi -

control the importationof mechanicaland electricalmachinery. Import bans

primarily cover many of the CBU items that are not listed as AT items but
which car.be importedin their .) form under the aforementionedIP license.

(xix) The IT license (348 items) is used to restrict imports to the

six State Trading Companies (STCs). In some instancesthese items are also
under an informalquota imposedby the Ministry of Trade. The objective is to
restrictthe overall level of itDorts and encouragethe developmentof STCs.
The items covered include all batik fabric and clothing,agriculturaltools,
electroniccomputer equipb.snt, salt and some fertilizertypes. The
determinationand allocationof quotas is non-transparent,and many end users
view the STCs as an tsnnecessarycost-raisingintermediary.

(xx) The PI license (269 items) is potentiallythe most restrictive

import license as it limits the importationof a range of items to designated
sole importers,many of whom are domesticproducersof the same final product.
In terms of domesticproductionand import value the most importantitems
under this category include: (a) selected steel, tin plate and aluminum
products which are restrictedto the state owned Krakatau Steel Industry and
Tambang Timah; (b) a range of agriculturalcommodities(includingrice, wheat,
wheat flour, sugar, soybeansand soybeanmeal) which are restrictedto BULOG
and account for over half of Indonesia'stotal food import bill; and (c) a
number of processedfood end beverage items that are restrictedto Tjipta
Niaga and Karta Niaga (two of the six STCs). With the exceptionof rice,
domestic consumersand downstreamusers of these PI productscomplain of high
prices, poor quality and uncertain delivery. Finally, there are about 105
products that were listed in the 1988 RestrictedGoods List but have proved
difficult to classifyunder any specificlicense type. This lack of clarity
is one of the negative featuresof allowingtrade policy to be determinedvia
multiple decrees issued by differentministries.

(xxi) Indonesia'simport tariff schedulehas 12 differentad valorem

rates, with 99Z of all items falling below the target tariff ceiling of 60X.
In January 1989, Indonesiaconvertedto the new HarmonizedSystem (HS) of
classifyingtraded goods. GOI used this opportunityto reduce the number of
specificduties from 498 to 19, which has improvedthe transparencyof the
tariff schedule. Unfortunately,the positiveeffects of this reform have been
more than offset by the increasedprevalenceof 'split'tariff positions and
surcharges. Although the originalHS scheduledid not contain any split
tariff positions,a series of decrees since January 1, 1989, have reintroduced
592 splits. As a result, the number of effectivetariff positions is now
9,662 comparedwith 9,070 in the originalHS schedule. In addition, the
number of items with surchargeshas increasedfrom 180 in mid-1988 to 376 at
the present time. The overall result of these developmentshas been a slight
increasein the average weighted tariff and a more significantincrease in t1he
dispersionof tariff rates since mid-1988. Split tariff positions and
surchargeahave been uisedto provide 'made to measure' assistanceto
particularproducts. In addition,they create uncertaintyfor those
administeringcustoms as well as importersbecause of the resultingdifficulty
of classifyinggoods and determiningwhether a surchargeapplies or not.
Finally, actual import tariff revenuesare less than half the average
statutoryimport rate, reflectingthe wide-spreaduse of import tariff
exemptions. Aside from the duty exemption scheme for exporters (BAPEKSTA)and
 - xii -

lower import tariffsunder ASEAN trade agreement,there are other exemption

schemeswhich may warrant review. These include exemptionsfor investments
approvedby BKPM, foreign aided projects, imports for the oil and gas industry
and importsby particulardomesticfirms.

(xxii) Indonesia'sexport regime is comprisedof two types of policy

intervention. First, there are several export policiesdesigned to regulate,
in most cases restrict,the export of designatedcommodities. These are
export bans, quotas, taxes, quality controlsand approvedexporter
arrangements. The government'sobjectivesin regulatingexports include:
taking advantageof Indonesia'sperceivedmarket powar; encouragingdomestic
processing;ensuring adequatedomesticsupply; and respondingto externally
imposed quotas. Second, there are a number of measures designedto directly
assist exporters. The most importantof these are the import duty exemption
and drawback scheme (BAPEKSTA)and the subsidizedexport credit program. The
objectivesof these measures are to offset the anti-exportbias created by the
import regime and to protect exportersfrom the resulting 'high cost economy'.

(xxiii) In contrastto the progressmade in deregulatingimport

regulations,domesticallyimposed export re2ulationshave increased. The
product coverageof export bans was broadenedin 1988 and the prevalenceof
approved exporterarrangementsappears to be spreading. It is estimated that
502 of total non-oil export trade is affectedby some form of regulation,with
most of these regulationsconcerningagriculturalor forestryproducts. While
the Government'sdesire to increasedomesticprocessingis understandable,
care needs to be taken in decidingon the appropriatepolicy instruments
throughwhich to achieve this objective. In general,the regulationof
exports is appropriateon economicgrounds only under very specific (and
rather uncommon)conditions. Experiencein other countrieswhich have imposed
export restrictions,provides strong evidencethat the dynamic effects are
often negative. In addition,aside from whether a product should be
regulated,a second but no less importantissue, concernshow a product is
regulated. The current range of bans, approvedexporterarrangements,
implicitquotas, etc., are not likely to achievethe government'sobjectives.
For some products,current holders of quetas play an importantrole in
determiningfuture quota allocationsand dcmesticsuppliersare enforcedto
sell through designatedexporters. This creases significantbarriers to new
more efficiententrantsand can result in a level of domesticmarket power
which is detrimentalto efficiencyand equity considerations.

(xxiv) There has also been a significantincreasein export assistance

measures. Almost a quarter of total non-oil exportsuse the BAPEKSTA facility
to access part of their importedinput needs, while the share of non-oil
exports supportedby export financingis estimatedat about two-thirds.
BAPEKSTAprovidestwo facilitiesthroughwhich exporterscan access imported
inputs free of both import duty/VATand license restrictions,i.e., the
exemptionscheme and the duty drawbackscheme. The exemption scheme has
worked extremelywell, with major users includingmany of the new emerging
export industriessuch as footwear,food products, rubber products,etc.
Interviewswith large and medium scale firms confirm the importanceof the
scheme and the high regard the private sector has for BAPEKSTA's
administrativeefficiency. However, small-scalefirms benefit less from the
exemptionfacilitybecause they are unable to order in large enough
 - xiii -

quantities,they are reluctantto disturb relationswith large domestic

suppliers,and BAPEKSTAapplicationproceduresare beyond their administrative
capacity. The duty drawbackfacilityhas been less successful,primarily
because final exporters find it difficultto get domesticsuppliersof
imported inputs to document import costs and duties paid.

(xxv) Although the existingexport financing,PEFG and ECI/G schemes have

supported the growth of Indonesia'snon-oil exports, they have had a limited
impact on broadeningthe export base or assistingindirectexporters. The
report identifiesa number of shortcomingswith the current schemes including:
(i) the preferentialinterestrates charged to the exporterhave encouraged
misuse of the export loan, whereby funds have been divertedby the borrower
for purposes other than exports; (ii) rationingof credit has restrictedits
use principallyto large, establishedexporters;(iii) the low intermediation
margins on export loans as compared to other commercialloans have discouraged
commercialbanks from extendingloans to small and new exporters; (iv) the
pre-shipmentexport finance guarantee systemwhich was expected to assure the
access of small and new firms to export loans has been unable to provide banks
with a substitutefor collateral;(v) indirectexporters,crucial to promote
backward integration,do not have easy and automaticaccess to officialexport
financingas well as duty free imports;and (vi) relativeto the number of
exporters,the export credit insurance/guarantee scheme has been utilizedby a
very limited number of products and exporters.

(xxvi) The current pattern of incentivesproducedby Indonesia'strade

regime have been estimated in terms of both nominal and effective ratps of
protection (NRPs and ERPs). The results show that there continuesto be a
strong anti-exportbias, as indicatedby comparingthe aggregateERP for all
import-competiting goods (44%) against that for all export-competinggoods
(-2Z). This bias in favor of import-competiting activitiesapplies between
sectors and within broad industrialgroups. For example,within primary
industries(agriculture,forestryand mining) export competiting
activities- such as logging, rattan, rubber,coffee and semi-processed
vegetableoils - have low ERPs and are subjectto bans, quotas and taxes;
whereas import-competingsectors - such as milk, soybeansand sugar - have
high ERPs and receivedirect or indirectsubsidies. In secondary industries
(manufacturingand processed agriculturecommodities)the same pattern of
incentivesis found, althoughthe picture is more complex due to Government's
efforts to stimulatenon-oil manufacturedexports at the same time as
continuingto protect existing import substitutionactivities.

(xxvii) There ._sa strong connectionbetween the share of domestic

productionprotectedby NTBs and relativeERPs. In manufacturing,four of the
five most highly protected activitiesin terms of NTB coveragealso rank
highest in terms of ERPs. Finally the current trade regime produces a wide
variance of protectionwithin the manufacturingand agriculturalsectors. For
example,even though the ERP for the basic iron and steel industryis
relativelylow, the index of dispersionis 120 comparedto an average of 42
for the manufacturingsector. Much of this variancein rates of protection
results from the use of split-tariffpositionsand import surchargesto
provide additionalprotectionto specificproducts.
 - xiv -

Effects of Trade Regime on SelectedManufacturingActivitied

(xxviii) The effects that the trade regime has on manufacturing

activitieshas been examinedby focusingon four industries(steel,paper,
textilesand footwear). These industrieshave been selectedto representthe
spectrumof manufacturingactivitiesin terms of their trade orientation,
i.e. ranging from primarily inward-oriented(steel)to outward-oriented
(footwear). As many of the effects of the trade regime are the same for
differentmanufacturingactivities,it is hoped that the lessonsprovidedby
these industrystudieswill have broader relevanceacross the whole
manufacturingsector.

(xxix) All of the selected industrieshave maintainedpositive growth

rates since the early 1980's,with the expansion in value added being
strongestin the outward-orientedindustriessince 1986. As the
outward-orientedindustriesare more labour intensivethan the inward-oriented
induscries,there has been a correspondingaccelerationin the rate of growth
in employment. There is also evidence of a move torwardsmore labour
intensiveproductswithin industries. Each of the industriesattainedhigher
export growth in the period 1986-88,comparedwith 1983-86. Even those
industriesthat are classifiedas being inward-oriented(e.g., steel, and to a
lesser extent paper) demonstratedthat there are certain productswithin these
industrieswhich can compete on the internationalmarket. Finally, in three
out of four of the industries(i.e., textiles,paper and steel) importsalso
increasedover the period 1986-88.

(xxx) The major trade policy issues that arise from these industry
studies differ accordingto the trade orientationof the industry. For those
industries,or parts of an industry,that are primarily geared towards import-
substitution,the most importanttrade policy issues are: the remaining
incidenceof NTBs, high tariff protectionon 'upstream'inputs,and the
increaseduse of split-tariffpositionsand surcharges. While the sequential
approachto trade reform has suited the Indonesiancontext, it has allowed
some manufacturingactivitiesto maintain their highly protected status. Some
non-competitiveactivitiesremain under NTBs (e.g., cold rolled steel
products)or have been partiallyderegulated(e.g.,moved to the less
restrictiveIP license)but accordedhigh import tariffs. In these cases,
tariff positionshave often been split to target the remainingNTBs or
surchargesto particularproductsor producers. This has resulted in a
fragmentationof the trade regime and a loss in transparency. It has also
significantlyincreasedthe dispersionof protectionwithin an industryand
reduced competitivepressures to restructure. Dowstreamusers of these
commoditiesthat produce for the domesticmarket, such as galvanizedsteel
sheet producers or tin can users, are particularlydisadvantagedas they
cannot use the BAPEKSTA facilityto obtain imported inputs.

(xxxi) Broadeningthe reform program to encompassthose activitiesthat

rely primarily on supplyinga highly protected domesticmarket will be
difficult - particularlywhere there is considerableexistingcapital stock.
Nevertheless,the hidden costs of not tacklingthese anomaliesare high both
in terms of slowing the furtherefficientdevelopmentof the manufacturing
sector and reducing the tax on Indonesianconsumers. In addition,there are
 - xv -

strong indicationsthat import-substituition industriesdo have the capacity

to restructurewhen faced with increasedcompetition. The recent expansionin
steel exports and reports from downstreamsteel users of a more 'businesslike'
attitude from large domestic steel supplierssupport this hypothesis. Where
restructuringis not possible, alternativesteps will need to be taken to deal
with the financial implicationsof further trade reform.

(x..Cii) For those industriesthat are outward-orientedthe most

importanttrade policy issues are: high tariffs (and a few NTBs) on their
imported inputs and the dependenceon BAPEKSTAthat this creates, the
increasinguse of export bans and taxes on upstreamnnprocesseddomestic
inputs, and the continuedhigh import tariffs on their outputs. Some of
Indonesia'sfastest growing export industriesreceive levels of protectionon
their domestic sales well above the manufacturingsector average. This
reflectsthe continuedprevalenceof relativelyhigh import tariffs (and in
some cases NTBs) on importedinputs and, as a consequences,even higher
tariffs on outputs. In some instances,these high levels of effective
protectionalso reflect export bans and taxes on upstreamdomestic inputs
(e.g., leather for footwearor rattan for furniture). Medium to large-scale
exportershave been able to circumventtariffs and NTBs on importedinputs by
using the BAPEKSTA facility. Nevertheless,BAPEKSTAhas been less successful
in assisting small-scaleand indirectexporters,and it cannot assist
producers for the domesticmarket. In addition,high tariffs on the cutput of
some export industries (e.g., textilesand footwear)has reduced the
competitivepressureon high cost producers for the local market. This has
penalized the Indonesianconsumerwho cannot buy goods at the export price.
There seems little doubt that these industriescan effectivelycompete on
world markets. The more efficientdomestic firms appear eager to establish
foreign joint ventures to gain access to technicalexpertiseand foreign
markets. The reductionof high import tariffs (with surchargeremoval a
priority)on outputs, combinedwith the removal of remainingNTBs and lower
tariffs on inputs would encourage furtherefficency gains. These reforms are
necessary to change the current situationwhereby international
competitiveness(and competitivepressureson domestic firms) is heavily
dependenton the continuedefficiencyof BAPEKSTA.

Effects of The Trade Regime On SelectedAgriculturalActivities

(xxxiii) Internationaltrade in Indonesia'sagriculturalproducts is more

highly regulatedthan trade in industrialproducts. While the share of
domesticproductionprotected from import competitionthrough NTBs is similar
in both sectors (about 402), agriculturediffers from manufacturingin that
most agriculturalexports are also regulated. However,despite the prevalence
of trade restrictions,the aggregate level of protectionprovided to
agricultureis lower than that for manufacturing.5/ Put another way,
agriculturalprices depart less, on average,from free trade prices than those
in manufacturing. This primarily reflectstwo importantcharacteristicsof
the trade regime as it pertains to agriculture. First, althoughinternational

5/ The average effective rate of protectionfor agricultureis 21?

comparedto 73? for manufacturing. It should be noted, however, that
this bias has been partially offset by large direct public investment
in agriculturalinfrastructure.
 - Zvi -

trade in rice is highly restricted,domestic rice prices have generallybeen

maintainedclose to world prices. Given the weight of rice in total
agriculturalproduction (about 652), this lowers the production-weighted
estimateof protection. Second, some of the importanttrade interventionsin
agricultureresult in a tax on domesticproducers rather than providing
assistance (e.g., crude palm oil, wood, leather, rattan, and rubber). This is
rarely the case in manufacturing.

(xxxiv) While the aggregatelevel of protectionfor agricultureis low

relative to manufacturing,there is an almost equally wide dispersionaround
this average. Thus, while many agriculturalproducts sell at close to world
prices, others trade well above import/exportparity (e.g., sugar, wheat,
refined edible oils and soybeanmeal). The overall conclusionof this report
is that substantialeconomicgains would result from relaxingand simplifying
the current restrictionson the internationaltrade of agricultural
commodities. More specifically,the removal of NTBs and loweringof import
tariffs on agriculturalcommoditieswould improve the allocationof
agriculturalresources,increasecompetitivepressures on traders and
producers,and benefit domesticconsumers. This should be accompaniedby a
review of the current coverageof export regulations. Where appropriate,
export restrictionsshould be removed. In those rare instanceswhen export
restrictionsare in the economysbest medium-term interest,the primary issue
is to design the policy interventionso as to minimize the negative effects on
producers. In regulatingexports, it is also importantnot to reduce domestic
competitionby creating domesticbarriersto entry into either trading or
producing agriculturalcommodities. While an export tax is preferableto
other forms of export regulation,where a quota is used it is importantto use
a transparentatd efficientquota allocationmechanism.

(xxxv) The report also examines the effect that the current trade
regime has on the productionof some processed food products. This is an area
where Indonesia is thought to have a potential comparativeadvantageand the
governmentis keen to encourage furthergrowth. The analysis shows that the
current trade regime provideshigh levels of protectionon both important
inputs (e.g., tin plate, sugar and tetrapak)and outputs (processedmeat,
fruit and vegetables). As a consequence,it is primarily the larger firms
that can compete on world markets because they are capable of using the import
duty exemption and export credit facilitiesto access inputs at world prices.
Smaller-scaleand indirectexporters are disadvantagedby the current trade
regime because they have iauchmore difficultyavoidingthe high cost of
imports. Producers for the domesticmarket are able to absorb high input
costs due to the correspondinglyhigh tariff and NTB protectionon final
processed food products. However, domesticdemand for these products is lower
than it would be at internationalprices and these firms are not competitive
on world markets.

A Policy Framework for Future Reform

(xxxvi) The strong positive responseof the economy to the deregulation

measures taken to date, has created a favorableenvironmentwithin which to
pursue further reform. Private aector confidencein the government's
 - xvii -

macroeconomicmanagementis strong and there are expectationsthat further

supportingmicroeconomicreformswill be forthcoming. This has resulted in a
marked jump in planned foreign and domesticprivate sector 'nvestment. A
further reduction in both the level and variance of protectionis needed to
attract this investmenttowards activitieswhere Indonesiahas a clear
comparativeadvantage. This will encourage the efficientallocationof scarce
investmentresourcesand avoid protectionistpressuresbuilding-upin the
future.

(xxxvii) Following the rapid growth of non-oil exports during 1986-89,

some slowdown in growth rates may be inevitable. This is not surprisingas
capacity utilizationbecomes more of a binding constraint. But this
underscoresthe importanceof a sound incentiveand regulatoryframeworkto
achieve the next stage of expansionof non-oil exports. Of particularconcern
is the recent slight appreciationof the real exchange rate and the continued
anti-exportbias of the trade regime. There is also some concern that the
complex domestic regulatoryframework (includingthe legal system) is slowing
the pace at which planned investmentis being realized. While Indonesiais
now seen as a new low-costAsian export base, furtherpolicy reform wili be
needed to take full advantageof this opportunity. The current robust
macroeconomicconditionswould argue for acceleratingthe pace of reform to
capitalizeon this opportunity.

(xxxviii) The broad objectivesunderlyingthe next phase of reform shoul4

be to move towards a more neutral and administratively simple trade regime.
This implies that there should be fewer trade policy interventions(e.g., a
reductionin restrictiveimport licensesand export regulations)and that the
bias in favor of producing for either the domesticmarket or the export market
should be reduced. It also implies that where trade policy interventionsare
considerednecessary,e.g., externallyimposed quotas, the administrative
implementationmechanism should be transparentand efficient. More
specifically,the next phase of reform should include:

o Reducing the coverageof NTBs from the current level of 292 of

total domesticproduction,focussingon areas in both the
manufacturingand agriculturalsector where NTBs provide high
protectionto domesticproduction.

O Initiatinga medium-termtariff reform program by eliminating

split-tariffpositions,phasing out surcharges,and announcinga
phased plan to lower the maximum tariff rate from 60K to 202 over
a specifiedtime period.

O Reviewing the economiccosts and benefitsof the currentmix of

export regulations(particularlyexport bans, quotas and approved
exporter arrangements)to reduce export restrictionsand, where
such restrictionsare justified,to improve the implementation
mechanisms.

o Improvingthe efficiencyand coverageof BAPEKSTA and the export

credit/insurancemechanism,as part of a generalmove towards
placing all export assistancemeasures on a more commercial
basis - includingthe removal of interestrate subsidies.
 - xviii -

o StrengtheningGOI's institutionalcapacity for analyzing trade

policy issues.

(mxxix) In terms of the timing and sequencingof the reform program, the
removal of import NTBs remains the first priority. It is recommendedhere that
the removal of these NTBs be accompaniedby the initial phase of tariff reform
and, if possible, the remov:l of those export restrictionsthat are clearly not
in the economy'sbest medium-terminterests. Based on the experienceof other
countries,it is also recommendedthat the tariff rationalizationprogram be
completedover a period of about three years. Other componentsof the trade
reform program, such as developinga strongerinstitutionalcapacity for
dealingwith trade issues, improvingBAPEKSTA,reviewingthe remainingexport
regulations,and phasing out export finaxce subsidies,could also be completed
within three years. While domesticpolitical,economicand social factorswill
determine the actual pace of reforms,studies of other countries indicatethat
this sequencingof reform steps is likely to achieve the strongesteconomic
results. These studies also indicatethat it is importantfor governmentsto
give the business communitya clear signal of the directionof future policy
change and to take steps to convincethe private sector that the reform program
will be implemented. GOI's strong track-recordin promptlyimplementing
difficultpolicy actions has enhancedthe Government'scredibilityand
therefore its ability to influenceprivate sector expectations.

(xl) Before elaboratingon the recommendedreform proposals,two

points should be emphasized. First, further trade reform needs to be
implementedwithin a balancedmacroeconomicpolicy frameworkwhich takes into
account adjustmentsin the trade regime. As noted in Chapter 1, the
consistencyof GOI's monetary, fiscal and exchangerate policy has been a
central feature of Indonesia'ssuccessfuleconomicadjustmentto the severe
external shocks experiencedsince the early 1980s. With the immediate
economiccrisis passed, however, it is no less importantto continueto use
these macroeconomicmeasures to maintain externaland internalbalance.
Second, to benefit fully from the proposed _rade reforms,complementaryaction
in other areas, such as the domesticregulatoryframeworkand the legal
system,will be required. There is some feeling in the businesscommunity
that reforms in the financialsector and to some extent import regulations
have been implementedat a faster pace than in other areas. A concerted
effort will be needed to maintain relativeprogress in deregulatingboth
domesticand foreign trade regulations,includingissues of implementationin
the provinces.

(xli) Non-TariffBarriersto Imports. As part of the overall strategy

to move to a trade regime based on tariff rather than import license
protection,GOI intends to eliminateall non-tariffbarriers on imports except
for a small group of products that are harmful to health, strategicto
national defense or involve speciai economicand social considerations. The
Government'scommitmentto attainingthis objectivehas been demonstratedby
the four trade deregulationpackagesthat have been implementedsince 1986.
Nevertheless,over 900 items remain on the RestrictedGoods List and, as
discussedabove, the resultingNTBs are the primary cause of importantprice
distortionsin manufacturingand agriculture. These price distortionshave
drawn resourcesinto activitiesin which Indonesiadoes not have a comparative
 - xix -

advantage (e.g., sugar or motor car production),increasedcosts for

downstream industries, and lowered the rate of economic growth and employment
creation at the economy-wide level.

(xlii) The reduction of NTBs can be approached in two ways. Eitber the
NTB on a particular product can be removed or the restrictivenessof a license
categorycan be reduced. The previousderegulationpackageshave used both
approaches,with an emphasis,quite correctly,on the former. Removing items
from the RestrictedGoods List (i.e., classifyinga good as IU) is
administrativelysimple and, more importantly,it unambigiouslyopens access
to all bona fide importers.6/ An importantobjectiveof Indonesia'sbroader
deregulationdrive is to simplifyand streamlineadministrativeproceduresso
as to encourageprivate sector initiativeand reduce the burden on Government
departments. The reclassification of productsunder the General Importer (IU)
license fulfillsthese objectives,and should remain the preferred option.
Where this has not been possible,or as an initialstep towards deregulation,
productshave been moved from highly restrictivelicense categoriesto less
restrictivelicense categories,and in some cases productshave been
classifiedunder more than one license category (e.g., IPIIT). One extension
of this approachwould be to reduce the number of restrictivelicense
categories. For example, the IT license category (which restrictsthe right
to import about 348 items to the six State Trading Corporations)could be
merged with the IP licensecategory. This would significantlybroaden access
to these goods, at the same time as giving the STCs time to adjust to a more
competitivetrading environment.

(xliii) Partly because of the scope of the previousderegulation

packages, the next phase of removingimport license restrictionswill entail
focusingon hitherto difficultareas. The reductionof the coverage of NTBs
below the current level of about a third of total domestic sales will involve:
(i) the removal of all remainingNTBs in industriesthat have already been
subject to deregulation(e.g., steel, textiles,chemicals,paper and
pharmaceuticals);(ii) reducingthe tradingmonopoliesthat BULOG and the STCs
have on agriculturalcommoditiesand processed food and beverages and
(iii) dismantlingthe current mix of import license restrictions,import bans
and domestic regulationsthat are used to protect the local mechanicaland
electronicgoods industry, includingheavy equipmentand motor cars.

(xliv) Tariff Reform. It has been five years since the last major
reform of Indonesia'stariff schedule. Since then, the substantialprogress
made in reducingNTBs has, as intended, increasedthe relativeimportanceof
tariffs in the incentive regime. At the same time, partly in responseto the
removal of NTBs, ad hoc changes have been introducedin the tariff structure
which have increasedthe level and dispersionof tariffs,particularlyin the
manufacturingsector. While the detrimentaleffect that the resulting import
tariff schedulehas had on exports has been partiallyoffset by an efficient

6/ For detaileddefinitionof the variou;simport licensetypes see

Chapter 2. Briefly, the IU license is non-restrictive,requiringonly
a business permit and a tax payers number. All other license
categories (i.e., IP, AT, IT and PI) are restrictiveto various
degrees.
 - xxr-

import duty exemption scheme (BAPEKSTA),this facilityhas been less

successfulin reachingsmall-scaleor indirectexporters. Moreover, BAPEKSTA
cannot assist disadvantagedproducers for the domesticmarket or Indonesian
consumers. Given the anticipatedremoval of more NTBs and the recent increase
in private investment,it is opportuneto considera systematicreform of the
current tariff schedule.

(xlv) The tariff reform program discussed in this report has been
designed to move towards a low and fairly uniform structureof statutory
tariff rates. The proposedprogram has two basic components. The first
involvesa "tidyingup" of the current schedulethrough the removal of split-
tariff positionsand the gradual eliminationof surcharges. The second is a
broad-basedstrategy involvingthe reductionof both average tariff rates and
the degree of tariff dispersion. The broad-basedreform is based on tariff
reductionsacross the whole tariff structureas opposed to reductionsin
tariffs for particularindustries. The industry-by-industry approach is not
recommendedbecause it can open the tariff reform process to protracted
negotiationswith affected groups, and it can result in a temporaryworsening
of price distortionsdue to complex inter-industrylinkages. Reducing tariffs
across the tariff structureis preferablebecause it appears even-handed,it
removes the discretionaryelement in decidingwhich industriesto focus on
first, and it is administrativelysimple. Finally,establishinga lower more
uniform import tariff would also relievethe administrativepressure currently
placed on BAPEKSTA. As non-oil exports expand further,the burden on BAPEKSTA
to efficientlyprocess a greaternumber of applicationswill grow. Lower
tariffswould reduce the incentivesto use BAPEKSTA, freeing BAPEKSTA'sstaff
resourcesto extend the scheme to capture small-scaleand indirectexporters.

(xlvi) It is proposed that split-tariffpositionsshould be removedby

absorbingthem back into the base-tariffposition. The import tariff
applicableto the new unified tariff positionshould be set as low possible.
With respect to surchargesit is recommendedthat a comprehensivereview be
undertakento determinewhich surchargesshould remain. Where it is decided
that the case for a temporarysurchargeis valid (i.e., due to the recent
removal of an NTB), it is recommendedthat the surcharge is phased out in a
systematicmanner. Where surchargeswere introducedas a mechanism to provide
temporaryprotection,it is proposedthat surchargesapply for only one year.
After that year, extensionswould be granted at a maximum rate equal to 501 of
the originalsurcharge. After the second year, all surchargeswould
automaticallyexpire, with no exceptions. The use of surchargesas an
anti-dumpingmechanism is not recommended. Surchargesapply to particular
commoditiesover a period of time whereas anti-dumpingproceduresconstitute
essentiallylegal actions by one party (for example,a firm) against another
with respect to a particularshipment. Thus, the appropriateresponseto
dumping is the impositionof specificpenalties related to a particular
supplier rather than measureswhich apply to a broad commoditygroup. If
dumping is indeed a significantproblem within certain industries,then the
appropriateresponse is to establishanti-dumpingprocedure alignedwith GATT
rules.

(xlvii) The above proposalsessentiallyset the stage for a much

broader-basedreform of the tariff schedule. The proposalhere is to reduce
the highest allowed tariff rates to a common ceiling,and then to lower the
 - xxi -

ceiling tariff over time. This 'tops down' approach results in a reduction in
the level and varianceof protectionat each step. The exact ceiling rates
and the phases of reform should be carefullychosen and clearly announcedat
the outset of the reform program. Such preannouncementsends a clear signal
to the business communityconcerningthe directionof future policy change
which will reduce investoruncertaintyand enable more informed investment
decisionsto be made. While there is flexibilityin the detailed design of
the reform program - the timetable,tariff rates, etc. - there is a strong
argumentto implement the reform in a relativelyshort period. Given the
likely resistanceto change from powerfulvested interests,the reform program
will be more credible if it can be announcedat a time of relative
macroeconomicstability and robust growth. In addition,the recent
significantjump in actual and planned investment,underlinesthe necessity of
creatingan incentive frameworkwhich channelsscarce investmentresource into
efficientactivities.

(xlviii) The proposal explored in this report is to move to a 502 ceiling

in year one, 302 in year two and 20? in year three. To establish the
credibilityof the program, the plan to introducea phased reduction in
maximum tariffs could be announcedat the same time as the 50? ceiling is
imposed and measures are taken to deal with splits and surcharges. In
addition,it may be worthwhileconsideringrationalizingthe tariff structure
further by imposingmore uniform rates within commoditygroups. This would
result in some low rates (zero or 5? import duties) being raised. Finally, it
would also be desirableto eliminatesome of the import duty exemptions,
replacingthem, where appropriate,with less distortionarycorporateor
investmenttax credits.

(xlix) The loss in governmenttax revenue resultingfrom the removal of

surchargesand adoptionof a 20? tariff-ceilingis estimated at about 1.3? of
total tax revenue. Even this low figure should be treated with caution as it
is a 'first-round'estimate,which does not reflect the beneficialeffects
that the reform will have on domesticgrowth, and hence import capacity. Nor
does this estimate take into account the revenue increasingeffect that the
further removal of NTBs will have. It is estimatedthat an increase in GDP of
around 2 per cent over the three year period of tariff reform would more than
offset the reductionsin import tariff revenue. In addition, the negative tax
revenue effects could be more than offset by the suggestedeliminationof
import duty exemptionsand, where appropriate,increasesin zero tariffs.

(1) Export Regulation. The trend towards increasedexport

regulationruns counter to the move towards treater deregulationof the
economy. Experiencein other countrieswhich have iaposed export
restrictions,indicatesthat the dynamic effects of these interventionsare
often negative. These restrictionsare particularworrisomewhere they create
artificialbarriers to entry and are non-transparent. Thus, even in those
limited instanceswhere there is a case for intervention,the appropriate
policy instrumentneeds to be carefullydesignedto minimize distortions.

(li) Where externalbarriersexist (i.e., textilesand tapioca), the

key requirementis to create an efficientand equitable quota allocation
mechanism. One option would be to improve the transparencyand efficiencyof
the Government'scurrent quota allocationmechanism and the operation of the
 - xxii -

quota exchangemarket. Another option would be to move to an open auction

system. Whatevermethod is used to allocatequotas, the existing
administrativecapacity to monitor quota utilizationfor each market should be
strengthened.

(lii) 2iere Indonesiacan influencethe wo'rldmarket price (e.g.,

logs, plywood, rattan,nutmeg and rubber),a theoreticalcase for an optimum
tax exists. The primary issue here is to set the tax at a level which
maximizes the economy'sgains over the medium-term. In the final analysis,
the use of an export restrictionis an empiri-al issue, which should be
approachedat the commodity level. A thorougheconomicanalysis should be
undertakenfor each regulatedproduct,with the burden of proof lying on the
need to regulate.7/ If it is decided to impose an export restriction,there
are strong economic reasons for choosingan export tax rather than imposinga
quota or ban.

(liii) Where Indonesiacannot influencethe world price, the case for

any type of export restrictionis weak. The result is to lower returns in
activitiesin which Indonesiais competitive(e.g., crude palm oil, crude
coconut oil and copra) in order to provide a subsidy to inefficientdownstream
processors (e.g., edible oil producers). This will lower investmentltechnical
change, and hence growth, in the taxed activity,as well as forsteringthe
developmentof an uncompetitivedownstreamindustry. In line with the
recommendationsmade in the Bank's recent Tree Crops report, all export
restrictionson commoditiesin this category should be removed. This should
include the removal of domesticmarket allocations.export or inter-island
taxes, and controlleddomesticprices.

(liv) Export Assistance. The duty exemption facilityoperacedby

BAPEKSTA operatesefficientlyand has providedessential support to
Indonesia'sexpandingnon-oil exports. However, the r±pid growth in the
utilizationof BAPEKSTA'sservices (currentlyover 20Z of non-oil exports)has
placed a strain on staff resources. In addition,the duty drawbackmechanism
has not been widely used, largelybecause of the requirementthat suppliers
furnish informationto the exporteron their import costs and duties.

(lv) In the near term, to ensure that the efficiencyof the exemption
mechanism ij maintained,modest additionalstaff resourcesand some technical
assistanceto BAPEKSTA should be considered. This should be coupledwith
continuedefforts to improve the transparencyand efficiencyof BAPEKSTA's
overall operation. BAPEKSTA'soperationscould also be improvedby modifying
the system for grantingduty drawbackto encouragegreater participationby
indirectexporters. One option explored in this report is to use the domestic
LIC system introducedby Bank Indonesia in October 1988 as an administrative
mechanism. While every effort should be made to increasethe efficiencyof
BAPEKSTA,this should not be viewed as a substitutefor continuedaction to
reduce import policy distortionsdirectly.

7/ An example of the type of economicanalysis requiredto determine if an

export tax is appropriateis provided in the World Bank's recent report
on the IndonesianTree Crops Sector - No. 7697-IND.
 - xxiii -

(lvi) The existingexport financing,loan guarantee and credit

insuranceschemes have also supportedthe rapid growth in Indonesia'snon-
oil/LNG exports. However,as discussedabove, the existing schemes appear to
have had only limited impact on broadeningthe export base or facilitating
backward linkages. In order to exploit fully the country'snon-oil export
potential,especiallynon-traditionalmanufacturedexports,it may be
desirable to extend equal and automaticaccess to export incentivesto all
firms that directlyor indirectlycontributeto export value added. This
should be relativelyeasy to accomplishin the Indonesiancontext;all the
instrumentsand institutionsare already in place and considerableexperience
has been gained in the administrationof incentivesin the last several years.

(lvii) With respect to export finance,it is recommendedthat the

export loan disbursementmechanismbe modernizedand the interest rate
differentialsand commercialbanks' intermediationmargin differentialbetween
export loans and other commercialloans be substantiallyreduced and /or
eliminated. In addition, Bank Indonesia should no longer pay half of the PEFG
premium and half of the losses resultingfrom exporters'non-performance. The
existing practice reduces the premium for the banks to only 0.252, leaves the
banks to absorb only 7.5Z of the loan losses, and gives them little incentive
to extend efforts to ensure that funds are being used for export purposes.

(lviii) The efficiencyof administeringPEFG requires: (i) close

coordinationbetween preshipmentexport financeguarantee (i.e., PT. ASEI) and
the pre-shipmentexport loan disbursementmechanism (i.e., Bank Indonesia);
(ii) PEFG beneficiariespaying the actual cost through appropriatepremium
rates; and (iii) operationaleffectivenessin the information-gatheringand
risk-poolingfunctions.Over time and after the institutionbuildingphase is
substantiallycompleted,the PEFG agency can also play an importantrole in
the risk-reductionby channelingtechnicalassistance,either directly through
in-houseactivitiesor indirectlythrough other specializedagencies.

(lix) Finally,with respect to the Export Credit Insurance/Guarantee

program, the most importantstep that can be taken is to familiarizethe banks
and exporterswith its availabilityand advantagesthrough an active, targeted
marketing campaign. In addition,new insurancepolicieswould need to be
designed to cover specificmedium-termtransactions,sales of services,
unconditionalguaranteeto banks, etc.
 CHAPTER .

TRADEPOLICY REFORMAND ECONOMIC

ADJUSTMENT

A. Introduction

1.01 Indonesia's trade policy strategy has changed significantly during

the 1980s. At the start of the decade the trade regime was inward-oriented,
promoting investmentby both the public and private sector in highly protected
activitiesgeared towards supplyingthe domesticmarket. Initiallythe
primary instrumentof protectionwas a high and disparate tariff structure.
From 1982, the steady weakening in the prices of Indonesia'scommodityexports
(particularlyoil) and the adverse effects of the world recession,resulted in
slower economicgrowth. While the Covernmentrespondedappropriatelyat the
macroeconomiclevel, by promptly implementinga stabilizationprogram designed
to reestablishfinancialstability(1982-85),the trade regime became more
inward-oriented. Faced with slower growth in domesticactivity and many
manufacturingplants carryingexcess capacity,tariff protectionwas
supplementedby a proliferationof non-tariffbarriers (NTBs) in the form of
restrictivelicense3. By the end of 1985, more than 1,700 tariff positions
were subject to import licensingaccountingfor over 402 of both import value
and traded domesticproduction. In addition,export restrictionsin the form
of bans, taxes and quotas became more commonplace- particularlyfor
unprocessedagriculturalcommodities. Thus, while short-termmacroeconomic
stabilitywas restoredby 1985, other medium-termstructuralproblems in the
economy had not been adequatelyaddressed.

1.02 The collapse in oil prices in early 1986, and the forecastof
continued slow domesticgrowth, encouragedGOI to reassessthis strategy. The
rapid decline in oil-relatedtax revenueand export earnings further curtailed
the Government'scapacityto financeplanned levels of public expenditureand
underlinedthe danger of fosteringa 'high cost' domesticmanufacturingsector
that was uncompetitiveon the world market. In response,the Government
implementeda series of "deregulationpackages' aimed at increasingprivate
sector activi.tyand stimulatingnon-oil exports. A key componentof these
packageshas been several trade reform measuresdesigned to improve the
internationalcompetitivenessof the economy and reduce the overall bias
against trade.l/ The primary focus of the trade reformshas been to move away
from a trade regime based upon non-tariffbarrierstowards a less 'Aistorted
regime based on import tariffs and to provide exporterswith access to
imported inputs at world prices. Prior to the May 1990 reforms,about half of
the restrictiveimport licenseshad been removed, loweringthe NTB coverageof
total domestic productionfrom 41% in 1986 to 29Z by end 1988. These measures
occurredwithin the context of a secondmacroeconomicstabilizationprogram
(1986-88),designedto promptly reduce the externaland internaldeficits that
had resultedfrom the further decline in oil prices and the adverse effects of
currencymovements on debt service payments.

1/ Since this report was preparedbefore the May 1990 reforms,the

analysis presentedhere does not reflect the implicationsof these new
measures.
 -2 -

1.03 The economy has respondedstronglyto the Government'sbalanced

adjustmentprogram. Since 1986, both the current account and budget deficit
have narrowO' significantly,inflationhas been containedat below 92 p.a.,
and economic growth has 'ccelerated. Of particularnote is the strong growth
in non-oil exports,which increasedfrom US$6.7 billion in 1986/87 to an
estimatedUS$12.1 billion in 1988/89. There has also been a marked increase
in private investment,particularlyplanned investment,and indicatorsof
overall economicefficiencyhave improvedsignificantlysince 1986. Indeed
there is mounting evidencethat the rate of economic growth during the
adjustmentperiod has been above previous estimates.21 This is particularly
so for manufacturingwhere most of the improvementsin the trade and
regulatoryenvironmenthave occurred. Aunotherimportantfinding is that
daregulationhas coincidedwith a strong surge in manufacturingemployment.
The change in domestic relativeprices resultingfrom both the macroeconomic
and trade/regulatoryreformshas drawn resourcesinto those relativelylabor
intensiveactivitiesin which Indonesiais competitivein the world market.

l.U4 The remainderof this Chapter investigatesrecent trends in the

economy in more detail, examining the changes in trade policy in the context
of broader macroeconomicdevelopments. The first section (8), describesthe
magnitude of the externalshock sufferedby the Indonesianeconomy and GOI's
correspondingpolicy response,includingtrade reform. The second section
(C), examinesthe degree to which these reformshave resulted in a change in
the overall pattern of incentives. Particularattentionis focussedon the
real exchange rate, the incidenceof NTBs, the tariff structure,export
incentivesand the relativeprice of tradables. The final section (D),
assesses the effects that the change in incentiveshas had on economic
performance. Severalmacroeconomicperformanceindicatorsare examined,
followedby a more detaileddiscussionof trends in imports,exports and the
performan_eof the manufacturingsector.

1.05 The followingchaptersof the report are organizedas follows:

Chapter 2 provides a detaileddiscussionof the current trade regime. It
takes a policy instrumentapproach,assessingthe incentiveeffects of each
importantpolicy instrument(i.e.,NTBs, import tariffs,export promotion
measures and export regulations). It concludesby providingan assessmentof
the overall pattern of incentivescreatedby the current trade regime in terms
of nominal and effectiverates of protection. Chapter 3 looks at the trade
regime from a differentangle by focussingon how the range of trade policy
instrumentsaffect particularmanufacturingactivities. Four industriesare
analyzed, coveringa range of inward and outward-oriented activitiesthat have
been effected by past trade reforms to differentdegrees.31 Chapter 4 extends
the analysisprovided in Chapter 3 to cover agr±culturalactivities. It is
important to acknowledgethat the effects of trade policy are not limited to

2I The revisednational accountsshow that between 1986 and 1988 GDP grew
by 5.32 p.a. and manufacturingby 12.52 p.a.

3/ The four industriesare footwear,textiles,iron and steel, and paper.

l
the manufacturingsector. This is particularlythe case in Indonesia,where
trade in agriculturalcommoditiesremainshighly regulated. Chapter 5
concludesby outlininga frameworkfor reform. It provides a series of both
short and long term policy steps designed to reduce the distortionaryeffects
of the trade regime and to create a policy frameworkconduciveto the further
developmentof Indonesia'seconomy.

B. MacroeconomicDevelopmentsand Trade Policy Reform

1.06 Since 1981, Indonesia has experienced a severe deterioration in its

external terms of trade. During the period 1982-85,the economy hiadto adjust
to the weakening of oil prices (from a peak of US$35 per barrel to
US$25 per barrel), the repercussionsof the 1982-84world recession,and a
decline in the price of several importantprimary commodityexports. Then, in
1986, the oil price collapsedfrom US$28 per barrel to a low of US$10
per barrel. Although oil prices did recover slightlythereafter,net oil/LNG
export earningsfell by US$2 billion between 1986 and 1988. These losses were
intensifiedby the adverse effects that internationalcurrency fluctuations
had on debt servicepayments from mid-1985. On average,Indonesia incurredan
income loss equivalentto some 9Z of its annual GNP over the period 1981 to
1988, due to externaldisturbances.3/

1.7 GOI respondedpromptly to this situationby adopting two successive

stabilizationprograms (1982-85and 1986-88). While both programs have been
based on appropriatemacroeconomicpoliciesdesignedto quickly restore
financial stability,the latter program focussedmore closely on undertaking
microeconomicreforms aimed at reducingthe complexityof the regulatory
frameworkand improvingthe incentivestructure. The specificpolicy
responsescan be grouped into four categories:

(a) To restorebalance of payments stabilityand sustain growth

over the medium term, the Governmentadopted an active
exchange rate policy. Major devaluationswere implementedin
March 1983 and September1986 and the flexibilityof the
exchange rate was increasedthrough a more activelymanaged
float. In conjunctionwith prudent fiscal and monetary
policies,these measures supporteda real effectiveexchange
rate depreciationof about 55Z between December 1981 and
December 1988. This played a key role in boostingnon-oil
exports and reducingthe current account deficit.

(b) The objectivesboth of demand restraintand structuralchange

have been served by the implementationof a number of strong
fiscal measures, designedto restrainpublic expenditure,
mobilize public revenuesand reduce the overall fiscal

3/ See Chapter 1 of the 1989 EconomicReport on Indonesia,entitled

Strategyfor Growth and StructuralChange for decompositionof the
externalshock and a more detaileddiscussionof the Government's
macroeconomicpolicy response.
 -4-

deficit. Budget austerityand more careful selectionof

ptojects reduced public investmentby over 30Z in real terms
over 1984-86,while tax reform measuresboosted non-oil tax
revenuesand improvedthe efficiencyof the tax system.

(c) Supportivemonetary and financialpolicieshave been

maintainedto contain inflationarypressures,prevent capital
flight,mobilize financialresourcesand improve the
efficiencyof use of financialresources. A major financial
sector reform was introducedin June 1983, which deregulated
domestic interestrates and increasedthe flexibilityof
monetarymanagement. A second round of financialmeasures
was initiatedin October-December1988, aimed at enhancing
tinancialsector efficiencyand boosting capitalmarkets.

(d) Startingin 1985, the Governmentalso initiateda series of

trade and other regulatoryreforms to support demand
managementpolicies in reducingmacroeconomicimbalancesand
to enable a recoveryof economicgrowth over the medium term.
These reformswere aimed at developinga more efficient
private sector, that can make a significantcontributionto
employmentgenerationand non-oil export development.

1.8 A key componentof point (d) above has been trade policy reform. The
first step towards improvingthe trade regime was taken in March 1985 when the
Governmentimplementeda comprehensivereform of the tariff schedule. The
tariff ceilingwas lowered from 225Z to 602,4/ and the number of tariff rates
was reduced from 25 to 11. The reform also raised the percentageof items
with tariffs below 30% from about 59X to 82Z. Although this resulted in an
unequivocalimprovementin trade regime, its effect was significantly
mitigatedby the simultaneousproliferationof restrictiveimport licenses.
Subsequently,in April 1985, the Governmentcompletelyreorganizedthe
customs,ports and shippingoperations. It placed the job of certifying
imports in the hands of a private firm of surveyors (SGS). This reduced both
the numbers of customs officials requiredand the discretionused at the port
of entry. As a result, the average time spent on customs procedureswas cut
by severalweeks, and the cost of freight forwardingboth for exports and
imports fell substantially.

1.9 Followingthe sharp drop in oil prices in 1986, the GOI embarkedupon
a more fundamentalseries of reforms designedto stimulatenon-oil exports and
increaseeconomicefficiency. In May 1986, the Governmentcreated a duty
exemptionand drawbackfacilityto enable exportersto access imported inputs
at world prices (BAPEKSTA,formerlyP4BM).5/ Indonesia'saccession to the
GATT Code on Subsidiesand CountervailingDuties in 1985 requiredwithdrawal

4/ Exceptionsto this tariff ceilingwere motor cars/cycles,some spare H

parts, and a range of productswith specificduties (e.g., tires) which
had high ad valorem equivalenttariffs - see Chapter 2.

5/ This facilitywas administeredby Pusat PengolahanPembebasandan

PengembalianBea Masuk (P4BM),which was later expanded and renamed
Badan Pelayanan KemudahanEkspor dan PengolahanData Keuangan
(BAPEKSTA)
 5-

of the Export CertificateScheme.6/ As a result, it became necessary to find

an alternativemethod to protect the competitivenessof Indonesianexporters
from the "high-cost"local economy and import license restrictions. The
BAPEKSTA facilitywas designed to do this by allowing 'producer-exporters" the
option of importing their inputs free of all trade and local taxes. The
significanceof the program goes beyond allowing imports to be brought in duty
free as it also allows exporters to bypass impert license restrictions. In
addition, a duty drawback facilitywas created to enable indirectexportersto
reclaim import duties.

1.10 In October 1986, followingthe 312 devaluationof the previousmonth,

GOI took the first step in directly reducingimport-policyrelated distortions
by announcingthe removal of 197 items from the RestrictedGoods List. The
Governmentindicated that this was the first of a series of trade reform
packages, designed to move away from a trade regime dependent on NTBs towards
one based solely on tariffs. Since 1986 there have been three further
packageswhich have focussedprimarilyon removingthe incidenceof NTBs in
manufacturing,where both the overall level and the variabilityin protection
is highest. lI addition,in 1987 the need to obtain an export licensewas
abolishedwhich opened export trade to all holders of a business license,
except those goods that are under specialexport regulations.7/ Finally,
followingthe reform of port proceduresin 1985, GOI have also taken several
steps to deregulatemaritime shipping. This culminatedin the November 1988
reform package which largely removed the remaining international shipping
restrictions, resulting in a marked increase in competition.

C. The Changing Pattern of Economic Incentives

1.11 One of the major objectives of GOI's adjustment program has been to
change the pattern of economic incentives. The rapid and sustained
deteriorationin Indonesia'sterms of trade coupledwith high cost local
industries,necessitatedrelativeprices to adjust in two ways. First, the
price of tradablesneeded to rise relativeto the price of non-tradables-
both to encourage domesticresourcesto switch into the productionof tradable
goods and to reduce the domesticdemand for tradablegoods. Second, the price
of exportablesneeded to rise relativeto the price of importables- to

6/ As a scheme for rebatingexports, the Export CertificateScheme

suffereda number of drawbacks. The level of payment often did not
relate to actual duty cost and was often viewed in importingcountries
as a direct subsidy. In addition,treatmentwas uneven, in some cases
actual payment was less than the duties borne: usually for the more
competitiveexporters able to competewithout subsidy. A final
difficultywas that, even if import duties were fully rebated,the
scheme did not provide a method of bypassingthe approvedtraders,and
therefore did not compensateexportersfor the costs imposed on them by
the restrictiveimport license system.

7/ See Chapter 2, Table 2.6 for list of export regulations. Export

regulationsare particularlycommon on unprocessedor semi-processed
agriculturalcommodities,e.g., logs, rattan, crude palm oil, and
sawnwood.
 - 6 -

further encourage resourcesto move into the productionof non-oil exports and
to increasethe pressure on import substitutionactivitiesto become more
competitive. At a macroeconomiclevel, the demand dampening And expenditure
switchingeffects of these relativeprice changeswere needed to facilitatea
correctionin the external current account deficit and to increaseeconomic
efficiency. In this sectionwe present severalmeasures or 'indicators'of
the degree to which the pattern of incentiveshave changed in responseto
GOI's adjustmentprogram. These are: the real exchangerate; the incidence
of NTBs; import tariffs;export incentives;the relativeprice of tradables;
and the cost of port clearanceand internationalshipping.

The Real ExchangeRate

1.12 Indonesiahas an unusuallystrong track record in following

consistentfiscal,monetary and exchange rate policiesas well as promptly
implementingappropriatemacroeconomicreforms in responseto changed economic
circumstances. The maxi-devaluationsof March 1983 (28Z) and September1986
(31Z),were both taken in responseto a significantand lastingdeterioration
in Indonesia'sexternal terms of trade. In both cases the devaluationof the
nominal exchange rate was supportedby appropriatemonetary and fiscal
policies designed to contain inflationarypressuresand thereby maintain the
gains in internationalcompetitiveness.

1.13 Two measures of the change in Indonesia'sreal exchange rate are

presented in Graphs 1.1 and 1.2. The first measures the change in the price
of Indonesia'straded goods (exportsand imports)relativeto the price of
traded goods in competitorcountries. It reflectsthe degree to which the
nominal devaluationand tight monetary and fiscal policies have lowered real
wages in Indonesiarelativeto competitorcountries. The second, measures the
change in the domesticwholesale price of manufacturedgoods relativeto the
domesticwholesale price of construction. This reflectsthe degree to which
the domesticprice of traded goods have changed relativeto the domesticprice
of non-tradedgoods. Both series tell roughly the same story. By following
consistentand mutually supportivemacroeconomicpolicies, GOI has
successfullymaintained the gains from the nominal devaluationthereby
increasingIndonesia'scompetitivenese.As expected these policieshave also
raised the price of tradablesrelativeto non-tradables. Both effectshelped
to offset the negativeeffects that the fall in oil prices had on the current
account,by reducingimport demand and by increasingthe profitabilityof
non-oil exports. One concern in this area is the recent slight appreciation
of the real exchange rate resultingfrom adjustmentsin the nominal exchange
rate not fully compensatingfor the prevailingrate of inflation (see
Graph 1.2).
 Graph 1.1 : REALEFFECTIVEEXCHANGERATE
INTERNATIONAL
COMPETITIVEEVS

120 -

110 -

100 -

90 -

60-
70-

40 . . . . . . I . -I ,
52 83 4 as 66 87 as so

SoureIMF:Defited as a Uadeweighted nominalefeeve exhangerate (basedon

index
tUde daat for bflazetaland third eounty mantnredgoods and primary goods
for a thme year period) adJusted for relativechanes in consur prices.

Graph 1.2: TRADEDvs NON-TRADED

GOODSPRICES

6-

4
3

7-2

0-3
-4

-3

-6

82 83 04 as 06 e7 as

Source: BPS: Defined as the change in the relativeprice of the

wholesaleprice index for non-traded commodities divided
by wholesaleprice for manufacturedexports.
 -8-

The Incidenceof NTBs

1.14 By the end of 1986, there were more than 1,700 products (CCCN tariff
positions)under NTBs, accountingfor over 402 of total import value and
traded domesticproduction.8/ Although import license restrictionsvaried
considerablyin their degree of restrictiveness, by 1986 the import licensing
system was the most importantdistortionaryinfluencein the trade regime,
contributingnot only to the high level and variabilityof protectionbut also
fosteringunproductive rent-seeking'behavior.

1.15 There have been four major trade reform packages since 1986, each one
of which has focused on reducingthe incidenceof NTBs in particularsectors.
Broadly speakingthe first three packagesincludedcompleteor partial
deregulationof: tires, glass and engineeringgoods (October1986 package);
textiles, garmentsand footwear (January1987 package); steel and mechanical
equipment (December1987 package). The fourth package in November 1988, was
the most significant,further deregulatingsteel and textilesand pushing the
reform effort into previouslyuntouched areas such as plastics, fertilizers,
and some processed food and beverages. The November package also requiredall
existing import licenseholders to reregisterat the regionaloffices of the
Ministry of Trade. This was designedto assist the non-oil tax drive by
bringingmore firms on to the tax registerand to screen out any illegal
importers.9/ One distinctbenefit of the new licensesis that they are valid
for as long as the importerremains in business,whereas previous licenseshad
to be renewed every three to five years.

1.16 The cumulativeimpact of the trade reform packages announcedbetween

October 1986 and end-1988 is shown in Table 1.1. In brief, these measures
resulted in the removalof 839 items from license control,accountingfor 48Z
of all items and 522 of total import value previouslyrestricted. More
importantly,the share of total domesticproductionprotected by import
licensing restrictionshas declinedby about a third, from 41Z to 292. The
reduction in NTBs has been concentratedin the manufacturingsector,where
both nominal and effectiverates of protectionare highest.10/ The share of
domesticmanufacturingproductioncovered by NTBs declinedfrom 682 in 1986 to
452 in 1988.

8/ Of the 1,700 items, 296 had a formal quota imposed. In addition,there

were 24 productsunder import ban (includingautomobiles,motorcycles,
televisionsand radios in their completelybuilt-upform).

9/ To qualify for a new import license,applicantshad to submit their

importeridentificationnumber (API), their tax registrationnumber
(NPWP),and have no record of contraveningprevailinglegislationand
regulations. Before reregistrationapproximately4,880 import licenses
had been issued. Of these, 3,667 reappliedwith 3,645 being approved
and 22 being rejected. Access by new importersremainedopen during,
and after, the registrationprocess. New entrantsrequire the same
documentationas those reregistering,and some 42 new importerswere
registeredin January and February 1989.

I
10/ See Chapter 2, paras 2.49 to 2.54, for estimatesof nominal and
effective rates of protection.
 - 9 -

Table 1l1s IMPACT OF REFORM PACKAGES ON IMPORT LICENSING COVERAGE SINCE 1986

Mid-1986 End-1987 End-1988

I of CCCN items 31.5 21.7 16.3

Z of import value 42.9 25.2 20.8
2 of total domesticproduction 41.4 37.6 28.9

Memo item:
Z of domestic production in: /a
Manufacturing 67.7 58.1 44.5
Agriculture 53.8 52.9 40.9
Mining and minerals 0.2 0.2 0.2

/a The estimates of domesticproductionunder import licenseprotectionfor

manufacturingand agriculturediffer from earlier Bank staff estimates
due to the reclassificationof the food and beveragesindustry into the
manufacturingsector and out of the agriculturalsector. This
reclassification, which has no impact on the economy-wideshare of total
domestic sales under NTBs, was done to maintainconsistencyin sector
definitionswith ti~enominal and effective rate estimates.

Source: World Bank staff estimates.

1.17 The removal of NTBs has had three beneficialeffects on the pattern
of lacentivesthat are difficultto separate. First, the move to tariff only
protectionhas reestablisheda direct link between domesticand world prices.
This has greatly increasedthe transparencyof the trade regime and
establisheda mechanism by which the level and variance in protectioncan be
lowered over time (i.e., by adjustmentsin the nominal tariff). Second, as
the data in paragraphs1.29 to 1.31 shows, the price of imports relativeto
the price of exports has fallen since 1986. At least part of this decline
reflectsthe removal of restrictiveimport licensingrequirements. Third,
domestic users of the deregulatedimportshave benefitednot only from lower
prices but also from more certain deliverytimes and improvedquality. As the
firm level evidencepresented in Chapter 3 indicates,such "non-price"factors
can be crucial in the export market, and can have importanteffects on
domestic producers encouragingthem to become more cost and quality conscious.

1.18 The Import Tariff Schedule. The most significantchange in the

Indonesiantariff scheduleoccurredin 1985, when an across-the-board
reduction in tariff rates was instituted. This reform lowered the ad valorem
tariff rate ceiling for most products from 2252 to 602 and collapsed the
number of tariff levels from 25 to 11. As shown in Table 1.2, this resulted
in a marked decline in the averageweighted si,atutory tariff from 22Z to 13Z
by import value or from 292 to 19Z by domesticproductionvalue. One negative
aspect of the 1985 tariff reform was the introductionof many specificduties
which had high ad valorem equivalentrates. This caused the index of
dispersionto increasesignificantlyfrom 61.5 to 107.8.
 - 10 -

Table 1.2: CHANGESIN THE TARIFF SCHEDULEFORTIE WOOLSECONOMY

SINCE 198Sla

Pre-1985 1985 1988 1989

Average Tariff Rates (2)

Unweighted 37.3 27.0 24.0 27.0
Weighted
- by import value 22.0 13.0 14.5 12.0
- by domesticproduction/b 29.0 19.0 18.0 19.0

Index of Dispersion Ic 61.5 107.8 90.0 92.7

/a 'Pre-1985"refers to the 1983 Tariff Law in effect from 1983 to 1985; i985
reflects rates in effect after the 1985 reform; 1988 refers to rates in
effect after the November 1988 package; and 1989 refers to the Harmonized
System as provided by the Departmentof Finance in mid-1989. Tariffs are
inclusiveof surcharges. Specificduties have been converted to ad
valorem equivalents.
lb Based on a sample of 1,200 tariff positions.
jc Measured by the coefficientof variation.

Source: Ministry of Finance,Central Bureau of Statisticsand staff

estimates.

1.19 From 198>,to 1988 the tariff schedulehas been subject to a number of
ad hoc changes associatedwith the series of deregulationpackages. These
changes have focused on raising some tariff rates to compensatefor the
removal of NTB protection,and loweringother tariff rates to offset the
effect of the September 1986 devaluationand to reduce the costs of imported
inputs that are not produced locally. In some instances,a surchargewas also
imposed to provide additionalprotectionto productsmoved off NTBs.ll/ The
surchargeprovision has also acquireda second function,in that it has been
increasinglyused as a de facto anti-dumpingmeasure. In some instances,
productshave been designatedas surchargeablebut with rates initially set at
zero. This has created a potentially'easy'mechanismby which additional
protectioncan be granted domesticproducers and, as discussedin Chapter 5,
does not constitutean appropriateanti-dumpingmechanism.

1.20 Another importantcharacteristicof recent changes in the tariff

schedulesince 1985 is the introductionof split-tariffpositions.12/ In many

11/ Although it is the Government'sintentionthat surchargesshould

automaticallyexpire after one year (unlessa valid case can be
presented for their renewal)this does not appear to have happened,
with the result that there is considerableuncertaintyconcerningtheir
validity.

121 This is the subdivisionof a standardCCCN or US tariff position into

ever finer product descriptions. See Chapter 2 for full discussion.
 - 11 -

cases these have been used to maintainprotectionto sub-groupsof products

produced domestically. The overall result of the changes since 1985 has been
a gradual decline in the index of dispersion,from 108 to 84, with little
impact on the overall average tariff rate. The overall dispersion index has
declinedprimarily because the ad valorem equivalentof specificduties have
diminishedover time (due to the effect of inflationand devaluation)and some
specificduties have been replacedwith ad valorem rates as part of the
deregulation packages. This has not resultedin a correspondingreductionin
the average tariff rate because of the offsettingeffect of the aforementioned
increasein tariff rates (includingsurcharges)associatedwith the move eway
from NTBs.

1.21 In January 1989, Indonesiaconvertedfrom the CCCN classification

system to the HarmonizedSystem. GOl used the opportunityto reduce the
number of items with specifictariffs from 498 items to 19.13/ This has
greatly improvedthe transparencyof the tariff schedule. Before this
conversion,the ad valorem equivalentof specificduties ranged from IOZ up to
100X. In the new HS system most of the specificduties have been replaced
with ad valorem rates in the 50? to 60X range. As a result, the move to ad
valorem rates has reduced the overall dispersionof the tariff schedulebut
has also resultedin a clusteringof tariff rates at the top of the tariff
(see Graph 1.3). A negative aspect of recent developmentsin the new HS
tariff schedule is the increasedprevalenceof surchargesand split-tariff
positions. This has resulted in average surchargesincreasingin a number of
industriesincludingfootwearand basic iron and steel products. In addition,
average tariff rates for a number of industries- most notably processed food,
footwear, rubber productsand glass have increasedsince 1988. The changes in
tariff and surchargeshave led to a slight increasein the unweightedand
productionweighted average tariffs for 1989. Dispersionhas also increased,
primarily due to the increaseduse of split-tariffposition. It would appear
that some of the earliermomentum towards tariff reform has been lost since
the conversionto the HarmonizedSystem.14/

131 The remaining19 specificduties apply to a sub-groupof rubber tires.

14/ A more detailed discussionof the incentiveeffects of the HS tariff

schedule is provided in Chapter 2.
 - 12 -

Graph 1.3: CHANGES 1985-89

IN THE TARIFF SCHEDULE
(including surcharges)

PRE-1985 CCCNSCHEDULE

S-U mp a"" 4eM Me emumVW

"",fa

1985 CCCNSCHEDULE

TNP RANE

1989 HS SCHEDULE

p
0

e4Mem 0eme em.m"0 -M

TAMPP ANGe
 - 13 -

Export Incentives

1.22 The most importantchange Ja export incer ves was the creationof
the duty exemptionand drawback scheme (BAPEKSTA)on May 6, 1986. The
BAPEKSTA facilitypartiallyprotectsexporters from the "high-cost"local
economy by allowingthem to import their inputs free of tar and, just as
important,by allowingthem to by-pass import license restrictions.15/ The
import exemption scheme has worked extremelywell. BAPEKSTAhas operatedwith
an "anrs length' administrationpolicy which minimizes direct contact with
potential applicantsand has made continuousefforts to simplify and
standardizeapplicationand processingprocedures. As shown in Table 1.3, the
number of firms using the scheme since 1986 has increasedrapidlywith
processingtime for applicationsfalling by 502.16/ The total value of
imports approved or realizedunder the scheme has more than doubled over the
past two years, to a level which accountsfor 17.02 and 7.52 of total non-oil
imports. The total value of exportswhich have benefittedfrom using facility
has also expanded rapidly to a level of 242 of total manufacturednon-oil
exports in 1988.

Table 1.3: IMPLEMENTATIONOP BAPERSTASCEMB

No. of Value of Imports Value of Taxesia ProcessingTime

Firms (US$ million) (US$ million) (No. of days)
Duty Duty For For
ApprovedRealized Exempt Drawback Exempt Drawback

1986 (July-Dec.) 242 236 65 76 0 12 24

1987 (Jan.-Dec.) 482 902 297 230 6 7 17
1988 (Jan.-Dec.) 1,098 2,447 626 855 20 6 13

/a On ai.proval
basis.

Sources BAPEKSTA.

15/ Import duty and VAT exemptionscan be given for either a firms total
importedinputs (if the firm exports 652 or more of total production)
or on a consignmentbasis (where a particularimport order is directly
linked to an export order). A duty-drawbackfacilityalso exists to
assist "indirect"exportersbut this has not been used extensivelyas
discussed in Chapter 2.

16/ In additionto the underlyinggrowth in the scheme, this rapid growth

reflectstwo changes in coverage: (a) the scheme was expanded to
incorporateforeign aided public sector projects;and (b) the
definitionof producer-exporters was changed in December 1987, when the
ceiling for qualifyingfor duty/taxexemptionwas lowered from 852 to
652 of total production(except for textilesproducers).
 - 14 -

1.23 It is also encouragingthat access to the scheme has broadened since

1986, to includemore of the 'emerging'sectors that have recentlyshown
strong export growth (see Table 1.4). In particular,food pr:oducts, footwear,
rubber products, textile and garmentsproducersand wood product manufacturers
all use the facilityfor part of their imported input needs. ?irm level
interviewswith textilesand footwearproducersconfirmed the importanceof
BAPEKSTA. Access to good quality and uniform material inputs was regardedas
being as importantas price considerationsby those producerssupplying
brand-namefootwearand garments to overseasbuyers. Some foreign producers
remarked that access to importedinputs was a more importantinfluenceon
their decisionto relocateto Indonesianthan the comparativelow Indonesian
wage rate. Finally, it is also clear that BAPEKSTA is used primarily to
import those items with above average levels of nominal tariff protectionx.
However, as shown in Table 1.5 the facility is also used to import some
items - such as chemicals,syntheticfibres, and iron steel products - where
the nominal tariff rate is low. In these cases BAPEKSTA is primarilyused to
overcomeNTB protection. Even where the domesticproduct may sell at close to
world prices, downstreamusers in the steel products and textiles sectors
often quoted problemsof deliveryand quality as reasons to use BAPEKSTA.
Indeed some firms indicatedthat by having BAPEKSTA approvalto import ensured
better servicesand more competitiveprices from domesticsuppliers - hence
part of the reason for the discrepancybetween approvalsand actual imports
under the BAPEKSTA facility.

Table 1.4: MANUFACTURINGEXPORTS UNDER WPERKSTA

(As percent of Total Exports)

Description 1986 1987 1989

Food and beverages 12 52 62

Textile,clothing and footwear 92 281 302
Wood products 152 37Z 452
Paper & paper products 92 312 432
Chemicals,rubber and plastic products 12 52 82
Non-metallicproducts 22 82 112
Basic metal products 12 422 312
Mechanicaland electronicalmachinery 32 202 362
Other 02 72 82

Source: BAPEKSTA.

i
 - 15 -

Table 1.5s MAIN I!EMS IMPORTED UNDERBAPEKSTADUTYEXEMPTION.

WITH AMOUNT OF EXEMPTIONAND AMOUNT OF IMPORT, MAY 1986 - JUNE 1989
(oanapprovalbasis)

Total Average
Commodity/Item Amount Imported Exemption Duty
(US$ million) (US$ million) (Z)

Manioc 49.2 14.7 302

Vegetable oils 49.1 34.5 702
Heterocycliccomp. 11.2 0.5 4Z
Other chemicals 14.5 0.9 62
Polycondensated 27.7 3.4 122
Polymers 62.2 14.0 23Z
Plastic containers 14.3 6.1 432
Cow leather 15.1 3.1 212
Paper (white) 16.0 4.2 262
Paper (coated) 10.7 2.3 212
Syntheticyarn 30.8 6.4 212
Woven syntheticfabric 31.0 18.8 612
Woven cotton 123.2 78.1 632
Syntheticfibers 29.3 4.4 152
Mixed yarn 25.0 5.0 20Z
Woven syntheticfabric 70.2 40.5 582
Knits, natural fiber 21.3 12.6 592
Sacks (jute) 136.5 40.5 302
Refractorybricks 23.8 1.2 52
Iron/steelpillets/slabs 101.1 5.1 52
Iron/steelsheets-plates 30.3 2.0 72
Aluminum ingots 21.1 1.4 72
Lifts, elevators conveyors 162.9 46.8 292
Excavators,shovels 21.9 6.9 322
Slide fasteners 19.0 14.7 772
Shovels 24.0 7.6 322
Average tariff 332
Average manufacturingimport tariff 192

Source: BAPEKSTA,Bank staff estimates.

1.24 Another importantpolicy componentof the export incentiveregime is

the provision of subsidizedshort-termexport financing,pre-shipmentexport
finance guarantee (PEFG) and export credit insurance/guarantee(ECI/G). These
measureswere announced in January 1982, and are available to all firms that
contributeto non-oil export value added. There has been a very rapid
increasein officialexport financingand pre-shipmentexport finance
guaranteelimits in the last few years, reflectingthe recent surge in non-oil
exports. While these measures have provided additionalexport incentives,the
subsidizedexport credit has been limitedto larger,well established
 - 16 -

exportersand the PEFG and ECI have not been effectivein encouragingbanks to
provide small or new firms access to credit. The amount of outstandingshort
term export credit (pre-shipmentand post-shipment)increasedon an average by
32.52 a year since 1982. Growth has been very rapid especiallyin the last
two years: while the rupiah value of non-oll exports almost doubled, the
outstandingexport loans almost tripled to reach 21Z of non-oil exports in
19881/9 (Table 1.6).17/Assuming such loans were revolvingevery four months,

Table 1.6: EXPORT LOANS OUTSTANDING,1985-89

(in billionsof Rupiah, as of March 31)

1985 '986 1987 1988 1989

Export Loans Outstanding 969 1,407 1,590 2,986 4,554

(LiquidityCredits) (635) (981) (1,492) (1,871) (2,595)
(PercentLiquidityCredits) (65.5) (69.7) (93.8) (62.7) (57.0)

Export Loans Outstandingby Sector

Agriculture 110 119 130 196 242
Industry 360 507 609 1,248 1,866
Trade 467 675 844 1,526 2,438
Other 32 26 215 16 8

As percent of
Non-oil Exports 14.7 16.1 14.3 18.4 21.3
Net DomesticCredit 8.6 7.0 9.0 10.0 10.9
Rupiah Bank Credit 5.1 6.3 5.8 8.8 10.2
Liquidity Credits /a 9.3 12.6 16.6 18.1 19.6

/a Rediscountableportion.

Source: Bank Indonesiaand World Bank staff.

17/ It is not possible to determinethe amount of exports actually

supportedby the export finance system (and the PEPG cover), since
actual loan ceilings, actual export transactionsand banks' usage of
Bank Indonesia liquiditycredit facilitycannot be matched. A
breakdownof total export loans outstandingas between pre-shipmentand
post-shipmentand by product and industryis unavailable. Because of
the prevalenceof sales on sight L/C basis, very little post-shipment
financing is obtainedby exporters (amountsinsuredwith PT. ASEI under
the ECI/G scheme constitutedless than 41 of outstandingexport loans
in 1988). Data by product and industryare not compiled; it is thus
not possible to determinewhich productslindustries are the major users
or to analyze the amount of subsidiesaccruing to differentgroups.
Interest rate subsidiesamountedto about rupiah 315 billion in 1988,
equivalentto about 22 of total non-oil/LNGexports.
 - 17 -

the share of non-oil/LNGexports supportedby the export financingscheme is

over 60?, a ratio which comparesvery favorablywith the other countries of
the region with similar schemes and partly reflectsthe inclusionof the main
primary products in the export financingscheme in Indonesia.

1.25 While data by product and industryare unavailable,trade and

manufacturingaccount for 95? of total outstandingexport loans. Export loans
have increasedfaster than most broad measures of credit. These loans now
constitute11?, 10? and 20? of net domesticcredit, total rupiah bank credit
and liquiditycredits respectively,compared to their share of 8.5?, 5 and 9?
only four years earlier. In large part, the relativelyrapid expansion in
export loans stems from Indonesia'sexport-ledgrowth of recent years. State
banks dominateeven though their share of total export loans outstandinghas
declined from over 90? in 1985 to 75? in 1989.

1.26 At the enactmentof the 1982 Export Policy, primary goods exporters
were charged an interestrate of 92, while non-primarygoods exporterswere
charged an interestrate of only 6? to encouragethe growth of non-traditional
exports. Under the monetary policy reform of June 1, 1983, interestrates
were un:fied at 9? for all non-oil/LNGexports.Since Indonesia'saccessionto
GATT Code on Subsidiesand CountervailingDuties in February1985 and in line
with a bilateralagreementwith the United States, large adjustmentshave been
made to reduce the interestrate subsidies. The bilateralagreementwith the
United States calls for complete eliminationof interestsubsidieson export
loans by April 1990, except for certain primary goods which would continueto
be eligible for subsidies. The agreed benchmarkfor unsubsidizedinterest
rate is the 3-month deposit rate of the state commercialbanks. In April
1987, GOI raised the interestrate on non-primarygoods from 9? to 11.5?.
EffectiveMay 1989 the interestrates on export loans were further increased
to 14? and 14.5? for primary and non-primarygoods respectively. Prior to May
1989 the interest rate on export loans was well below the cost of commercial
financing (see Table 1.7). However,while interestrates on export loans have
been substantiallyless than other non-preferentialrates, interestrates
since 1984 have been positivein real terms when measured in the context of
domesticinflation (CPI). With the May 1989 adjustmentin the interest rates,
real interestrates on export loans are currently in the 6-7? range.

1.27 In line with the incr-- e in outstandingcredits,the (obligatory)

preshipmentexport financeguarantee (PEFG) limits has also grown rapidly. By
contrast,the (optional)export credit insurance (ECI/G)activityhas
stagnated. Due to difficultiesin resolvingclaims and doubts about the
financialviability of the state-controlled insurancecompany (P.T. ASEI)
neither the PEFG or ECI/G have providedincentivesto Banks to extend
additionalcredit to exporters.181

1.28 The one policy developmentthat runs counter to tt'emeasures

consideredso far is the increasedcoverage of export regulations. During
1988, the existingexport ban on raw rattan was extendedto cover
semi-processedrattan and a new export ban was introducedfor SIR-SO rubber.

18/ See Chapter 2 for discussionof PEFG and ECI/G.

 - 18 -

The governmenthave also announced plans to extend the ban on logs to include
sawn timber. The objectiveunderlyingmost export restrictionsis primarily
to encouragedomestic processingor "value-added". In many cases, the more
immediateeffect is to lower the domesticprice of the restricteditem,
causing export prices to fall relativeto import prices.19/ While this does
encourage downstreamprocessingindustries,the value added by the downstream
processorsmay not exceed the real costs of adding the value - particularlyif
the losses incurredby producersof the restrictedcommodity are correctly
accountedfor.20/

Table 1.7: LENDING RATES AT DEPOSITMONEY BANKS

(in percentage,in March of year indicated)

1984 1985 1986 1987 1988 1989

Export Loans /a 9.0 9.0 9.0 9.0 11.5 14.5

Average on Working Capital:
State banks 18.2 19.9 19.0 18.4 19.7 20.5
Private national banks /b 24.4 26.2 23.8 22.9 23.5 23.5
Foreign banks 21.3 26.4 22.2 22.2 23.1 22.8
All deposit money banks 21.5 23.4 21.8 21.0 22.0 22.3
3-Month Deposit Rate
(state banks) /c 16.3 16.4 14.3 16.4 17.4 16.7
Domestic Inflation
CPI 9.8 4.9 6.2 9.5 5.3 7.0
WPI (excl. oil exports) 10.0 5.5 7.8 16.8 10.3

ia Non-primaryexports.
/b Foreign exchangebanks.
/c Benchmark rate under the bilateralagreement.

Source: Bank Indonesia.

19/ In those rare cases where Indonesiacan influenceworld prices, an

optimal export tax may raise export prices and, therefore,be to
Indonesia'sadvantage. However,importantdynamic considerationsmust
be taken into account such as foreignconsumers switchingto substitute
goods an;'third countriesincreasingtheir output of the restricted
export. In addition,a ban is seldom a useful method of exploiting
monopoly power, even a monopolistcannot gain from refusing to trade at
all.

20/ See Chapter 2, para 2.23 to 2.33 for a fuller discussionof this issue.
 - 19 -

The Relative Price of Tradables

1.29 If the partial removal of import restrictionsand the introductionof

BAPEKSTAhave had their intendedeffect, the domesticprice of highly
protected import substituteactivitiesshould have declined relativeto
exportedgoods. As noted in the opening paragraphsof this section,one of
the major objectivesof Indonesia'strade reform is to increasethe
profitabilityof exports relativeto imports and non-tradedgoods.

1.30 There are three manufacturedcommoditiesfor which wholesaleprice

data exist for both import and export competinggoods, i.e., textiles,
chemicalsand processed food. The first two commoditieshave experienceda
significantrelaxationof import license restrictions,whereas exporters of
the third (processedfood) have gained significantlyfrom the BAPEKSTA
facility.21/ The movements in the domesticWPI for export competing goods
relativeto import competing goods, since 1986, are shown in Table 1.8.

Table 1.8: CHANGE IN WHOLESALE PRICE OF EXPORTS RELATIVE

TO IMPORTS, 1986 - 100

ProcessedFood Textiles Chemicals

1986 100 100 100

1987 113 109 104
1988 113 109 107

Source: BPS, WholesalePrice Index.

1.31 These data indicatethat since 1986 the domesticprices of exported

manufacturedproductshave risen by between 7Z to 13Z relativeto importable
manufacturedproducts. These price changes have provided an incentive,in
additionto the exchange rate effect, to switch consumptionaway from
exportables while providing firms with an incentiveto expand the production
of exportables. Both effects tend to raise the exports of the products
concern and help redress the external deficit in the balance of payments.

Port Clearanceand ShippingCost

1.32 The costs of both processinggoods through Indonesiaports and

maritime transporthave been significantlyreducedby recent policy reforms.
Until the mid-1980s these serviceswere highly regulatedwith long delays in

211 The effect of trade policy reforms in the textile and processed food
industry are discussed in detail in Chapters 3 and 4 respectively.
 - 20 -

ports, controls on transporttariffs,licenseson routes and a range of other

permits. This restrictednew private investmentin the sector, reduced
flexibilityand raised transportcosts to very high levels. The most
deleteriousregulationswere in the maritime subsector. A start was made in
1985 to reform the ports when the Governmentreplacedcustoms serviceswith a
private sector organizationand restructuredport operations. As a result of
those reforms,cargo clearanceand ship turnaroundtimes were reduced
substantially,freight rates for exports and importsdeclinedmarkedly on many
routes, and the quality of servicesto shippersand consigneesimprovedas
internationalserviceswere extendedto more ports. However, the performance
of national shippingcompaniescontinuedto be constrainedby excessive
controlsover investmentand operatingdecisionsand by the policy of
compulsoryscrappingof ships beyond a certain age that was introducedin
1984. The scrappingpolicy reduced capacityand raised costs even further.

1.33 The Governmentintroduceda sweepingrange of reforms in 1988 to

address these concerns. First, the compulsoryscrappingpolicy was suspended
in February1988. This was followedby the announcementof a second package
of maritime reforms on November21, 1988. This package:

o reduced the categoriesof shippingbusiness licensesfrom five to

two;

o relaxed vessel ownershiprestrictions;

o permittednational and foreign lines to establish joint venture

companies to serve domesticand internationalroutes;

o eliminatedthe separateshippingoperating license;

o freed companiesto transportown products and raw materialswithout a

shippingbusiness license;

o permitted shippinglines to determinetheir own route structures,

vessel assignmentsand sailing frequencieswithout government
approval;

o permittednational lines to charter foreign flag vessels to serve

domestic routes without governmentapproval;

o allowed Indonesiancompaniesto buy or sell Indonesianvessels, or

dock them, without governmentapproval;and

o lifted the freeze on the issue of general cargo shippingbusiness

licenses-- in effect since 1976 -- and simplifies and streamlines
the applicationprocess.

1.34 By reducingand simplifyingbusiness licensingprocedures,by

allowing shippinglines to determinetheir own route structuresand schedules,
and by easing entry by both foreignand domesticcompanies,this set of
reforms removed virtually all regulatoryimpedimentsto the developmentof an
 - 21 -

efficient and responsivemaritime transportindustry. A preliminaryjudgement

is that as a result Indonesianow has a more open and unregulatedshipping
industrythan most other maritimenations. In response,over 40 new shipping
companieshave already been licensed. This resurgenceof competitionis
having a positiveeffect on the quality of shippingservicesand transport
costs.

D. The Effects of Policy Reform

1.35 The responseof the Indonesianeconomy to the Government'sadjustment

program has been impressive. Overall financialstabilityhas been restored
while economic growth has been maintained. Of particularnote is the strong
increase in both non-oil exports and private sector investment. Macroeconomic
indicatorsof efficiencyand factor productivityhave also improved. Indeed
there is mounting evidencethat the rate of growth during the second
adjustmentperiod (1986-88)has been significantlyabove previousestimates.
This is particularlyso for manufacturing,where most of the improvementsin
the trade and regulatoryenvironmenthave occurred. Another importantfinding
is that deregulationhas coincidedwith a strong surge in manufacturing
employment. The changes in relativeprices outlined in the previous section
have drawn resources into labor intensiveactivities,resultingin an
accelerationin the growth of employmentin medium and large scale industries.

1.36 This section analysesthese recent trends in more detail focussingon

what has been the responseof the economy to GOI's overall adjustmentprogram.
It also exploreswhether there is any evidence that trade reform has had an
additionaleffect on economicperformance. While the broad-basednature of
GOI's reform program makes it difficultto attributechanges in economic
performanceto specificpolicy reforms,some insights into the effects of
trade reform can be gained by comparing the trends in relevanteconomic
indicatorsfor the two stabilizationperiods (1982-85and 1986-88). While
both periods were characterizedby similarexternal shocks followedby
appropriatemacroeconomicpolicies,the latter period includeda more
determinedeffort to broaden the reform agenda to include changes in the trade
and regulatoryframework. In exploringthis approachwe initiallyinviestigate
trends in selectedmacroeconomicindicatorsof performanceover the two
stabilizationperiods. This is followedby a more detailed analysisof recent
trends in imports,exports and the manufacturingsector. While it may be too
early to determine the full impact of the deregulatoryreforms,trends in
these three areas may yield some useful preliminaryevidence.

MacroeconomicPerformance

1.37 As summarizedin Table 1.9, GOI has made good progress in restoring
financial stabilityand stimulatingeconomicgrowth. During the initialphase
of adjustment (1982-85)the current account deficit was quickly brought down
from 7.9Z of GNP in 1982 to 2.42 in 1985. As discussed in more detail below,
 - 21 -

efficient and responsivemaritime transportindustry. A preliminaryjudgement

is that as a result Indonesianow has a more open and unregulatedshipping
industrythan most other maritimenations. In response,over 40 new shipping
companieshave already been licensed. This resurgenceof competitionis
having a positive effect on the quality of shipping servicesand transport
costs.

D. The Effects of Policy Reform

1.35 The responseof the Indonesianeconomy to the Government'sadjustment

program has been impressive. Overall financialstabilityhas been restored
while economic growth has been maintained. Of particularnote is the strong
increasein both non-oil exports and private sector investment. Macroeconomic
indicatorsof efficiencyand factor productivityhave also improved. Indeed
there is mounting evidence that the rate of growth during the second
adjustmentperiod (1986-88)has been significantlyabove previous estimates.
This is particularlyso for manufacturing,where most of the improvementsin
the trade and regulatoryenvironmenthave occurred. Another importantfinding
is that deregulationhas coincidedwith a strong surge in manufacturing
employment. The changes in relativeprices outlinedin the previous section
have drawn resourcesinto labor intensiveactivities,resultingin an
accelerationin the growth of employmentin medium and large scale industries.

1.36 This section analysesthese recent trends in more detail focussingon

what has been the responseof the economy to GOI's overall adjustmentprogram.
It also exploreswhether there is any evidence that trade reform has had an
additionaleffect on economicperformance. While the broad-basednature of
GOI's reform program makes it difficult to attributechanges in economic
performanceto specificpolicy reforms,some insightsinto the effects of
trade reform can be gained by comparingthe trends in relevanteconomic
indicatorsfor the two stabilizationperiods (1982-85and 1986-88). While
both periods were characterizedby similar externalshocks followedby
appropriatemacroeconomicpolicies,the latter period includeda more
determinedeffort to broaden the reform agenda to includechanges In the trade
and regulatoryframework. In exploringthis approachwe initially investigate
trends in selectedmacroeconomicindicatorsof performanceover the two
stabilizationperiods. This is followedby a more detailedanalysisof recent
trends in imports,exports and the manufacturingsector. While it may be too
early to determinethe full impact of the deregulatoryreforms,trends in
these three areas may yield some useful preliminaryevidence.

MacroeconomicPerformance

1.37 As summarizedin Table 1.9, GOI has made good progress in restoring
financial stabilityand stimulatingeconomic growth. During the initialphase
of adjustment (1982-85)the current account deficit was quickly brought down
from 7.92 of GNP in 1982 to 2.4Z in 1985. As discussed in more detail below,
 - 23 -

1.38 The Government'sfiscal and monetarymanagementhas been at the

center of Indonesia'ssuccess in reducing internalimbalancesand containing
inflation. As a result of a major tax refonm effort which was initiatedin
January 1984, non-oil taxes grew from 7.4? of non-oil GDP in 1982 to 8.4% by
1985 and 10.8? by 1988. Combinedwith expenditurerestraintthis has reduced
the overall fiscal deficit from 4.9Z of GDP in 1982 to 3.4? in 1988. Budget
austerity and appropriatemonetary policy have containedinflationto less
than 10? since 1985, which in turn has preserved the competitiveadvantage
provided by the realignmentof the nominal exchange rate in both 1983 and
1986. As noted in the latest EconomicReport, the close coordinationof
exchange rate, fiscal and monetary policieshas been a distinguishingfeature
of the Government'smacroeconomicpolicy framework.

Table 1.10: MACROECONOMICEFFICIENCYINDICATORS

1973-81 1982-85 1986-88

Rate of return on investment(Z p.a.) 31.4 13.1 21.8

ICOR 2.8 7.8 5.2
Total factor productivitychange (? p.a.) 0.9 -2.5 1.0

Source: World Bank staff estimates.

1.39 The trend in both private sector investmentand aggregateefficiency

indicatorsdiffer markedlybetween the two stabilizationperiods. In the
initial adjustmentphase, private investmentdeclineddue to higher real
interestrates and lower aggregatedemand. Since 1986, however, private
investmenthas recoveredstrongly,respondingto the improvedincentiveand
regulatoryframeworkcreated by the post-1985reforms and the resultinghigher
level of economic activity. Much of this new investmenthas been directed
towards export activities. As shown in Table 1.10, indicatorsof efficiency
mirror this pattern. The average rate of return on investmentincreasedfrom
132 during the 1982-85 period to 22? in 1986-88. Similarly,over the same
period, the incrementalcapital-outputratio (ICOR) fell from 7.8 to 5.2 and
the average contributionof total factor productivityto economicgrowth
improved from -2.5 p.a. (implyinga fall) to 1? p.a.

1.40 The positiveeffects that GOI's macroeconomicpoliciesand

deregulationreforms have had on the private sector is substantiatedby the
recent surge in both domesticand foreign private investment. Domestic
investmentapprovalsby the InvestmentAuthority (BPKM)which had sagged since
1983, rose by 134? in 1987 and a further 45? in 1988. Similarly,after
recordinga sharp and steady decline since 1983, foreign investmentapprovals
in dollar terms rose by 76Z in 1987 and a remarkable300? in 1988 to
US$4.4 billion, a level that surpassesother East Asian economies. Data for
the first six months of 1989, indicatethat this higher level is being
 - 23 _

1.38 The Government'sfiscal and monetarymanagementhas been at the

center of Indonesia'ssuccess in reducinginternal imbalancesand containing
inflation. As a result of a major tax reform effort which was initiatedin
January 1984, non-oil taxes grew from 7.4Z of non-oil GDP in 1982 to 8.4Z by
1985 and 10.8Z by 1988. Combinedwith expenditurerestraintthis hae reduced
the overall fiscal deficit from 4.92 of GDP in 1982 to 3.4Z in 1988. Budget
austerity and appropriatemonetarypolicy have contained inflationto less
than 102 since 1985, which in turn has preserved the competitiveadvantage
providedby the realignmentof the nominal exchange rate in both 1983 and
1986. As noted in the latest EconomicIteport,the close coordinationof
exchange rate, fiscal and monetary polioieshas been a distinguishingfeature
of the Government'smacroeconomicpolicy framework.

Table 1.10: EFFICIENCYINDICATORS

MACROECONOMIC

1973-81 1982-85 1986-88

Rate of return on investment (2 p.a.) 31.4 13.1 21.8

ICOR 2.8 7.8 5.2
Total factor productivitychange (t p.a.) 0.9 -2.5 1.0

Source: World Bank staff estimates.

1.39 The trend in both private sector investmentand aggregateefficiency

indicatorsdiffer markedlybetween the two stabilizationperiods. In the
initial adjustmentphase, private investmentdeclineddue to higher real
interestrates and lower aggregatedemand. Since 1986, however, private
investmenthas recoveredstrongly,respondingto the improved incentiveand
regulatoryframeworkcreated by the post-1985 reforms and the resultinghigher
level of economicactivity. Much of this new investmenthas been directed
towards export activities. As shown in Table 1.10, indicatorsof efficiency
mirror this pattern. The average rate of return on investmentincreasedfrom
13S during the 1982-85 period to 22Z in 1986-88. Similarly,over the same
period, the incrementalcapital-outputratio (ICOR) fell from 7.8 to 5.2 and
the average contributionof total factor productivityto economicgrowth
improvedfrom -2.5 p.a. (implyinga fall) to 12 p.a.

1.40 The positive effects that GOI's macroeconomicpoliciesand

deregulationreforms have had on the private sector is substantiatedby the
recent surge in both domestic and foreignprivate investment. Domestic
investmentapprovalsby the InvestmentAuthority (BPKM)which had sagged since
1983, rose by 134? in 1987 and a further 45Z in 1988. Similarly,after
recordinga sharp and steady decline since 1983, foreign investmentapprovals
in dollar terms rose by 762 in 1987 and a remarkable3002 in 1988 to
US$4.4 billion,a level that surpassesother East Asian economies. Data for
the first six months of 1989. indicatethat this higher level is being
 - 25 -

maintained. While this increase in private sector activity is extremely

encouragingtwo importantcaveats should be noted. First, there are some
indicationsthat the realizationof investmentis lagging appreciablybehind
approvals,which partly reflectsimplementationproblems associatedwith the
remainingcomplexitiesof the domestic regulatoryframework,includingthe
weak corporate legal system. Second, it is not clear that all the new
investmentis being channelledinto areas where Indonesiahas a solid
comparativeadvantage (see Table 1.11). While the bulk of the growth in
domestic investmentis in export-competingsectors (e.g., agricultural
commodities,food, textiles,wood, and hotels), some of the larger foreign and
domestic investmentsare in import-substitution activities (e.g., chemicals
and metal industries). Further measures to reduce import protection
(includingin import tariffs),will be requiredto ensure that these
import-substitutionactivitiesare internationallycompetitive.

Table 1.12 TRENDS IN REAL RUPIAB WAGES 1981 TO 1988La

Wages Wages/CPI Wages/WPI

(Rp./day) (1981 = 100) (1981 - 100)

1981 1,056 100 100

1985 2,116 142 135

1986 2,343 149 139
1987 2,581 150 133
1988 /a 2,851 154 134

/a CPI measures change in consumergoods prices

for major cities, the WPI measures change in
prices for all industrialsectors.

Source: BPS and staff estimate.

1.41 Despite these caveats,it is clear that the gains in economic

efficiencyand the mobilizationof non-oil resourceshave sustained a
better-than-expected rate of economicgrowth, despite the loss of oil
revenues. The growth in non-oil GDP slowed to 4.02 during the initial
adjustmentperiod, resulting in a positivebut small gain in gross national
income of 1.3Z. During the second adjustmentperiod, GNP growth accelerated
to 4.6Z in 1987 and 5.72 in 1988 with a correspondingincreasein the growth
of GNY (see Table 1.9). Nevertheless,the adjustmentprocess has inevitably
involved short-termcosts. Despite the recent recoveryin economicgrowth,
per capita income has been adverselyaffectedby the terms of trade loss.
Part of the labor market adjustmenthas resultedin increasedopen
unemploymentin urban areas, especiallyamong young school l?avers. However,
the main adjustmenthas fallen on earnings. Table 1.12 shows that the
deteriorationin the terms of trade since 1981 has sharply slowed the growth
 - 26 -

of real rupiah wages relativeto the CPI, but has not resultedin an absolute
fall. At the same time real rupish wages did fall slightlyrelative to the
WPT for manufacturedgoods. The differentmovement in these two indices of
real wage since 1986 reflectsthe depreciationof the real exchange rate.
which has allowed averagewages to rise relativeto consumerprices (which
includesmany non-tradableitems) but to fall relativeto the price of
manufactured goods (which produces predominantly tradable items).

Imports

1.42 The pattern in import growth over the period 1983 to 1988, and the
two stabilizationsub-periods,is summarizedby broad economic category (BEC)
in Table 1.13. For the period as a whole, imports declinedby an average of
62 p.a., but trends during the two stabilizationperiods differedmarkedly.
In the first period, there was a decline across all BECs, with particularly
large falls in processed food and beverages for household consumption (which
fell by an average of 43Z p.a. between 1983 to 1986), capital goods (down 182)
and passengermotor cars (down 42Z). In the second period, both capital goods
and intermediategoods have increased,offsettingthe continueddecline in
consumergoods imports.

Table 1.13: GROWTH IN IMPORTS BY BROAD ECONOMICCATEGORIES,1983 - 1988

Real Growth Rates

1983-86 1986-88 1983-88
(Percentper year)

Total imports -12.5 4.7 -6.0

Capital goods -17.7 6.6 -8.7
Intermediategoods -8.7 4.6 -3.6
Consumergoods -20.9 -3.9 -14.5

Source: BPS.

1.43 The behavior of imports is broadly consistentwith the changes in

incentives: the overall decline in the period 1983-86 coincidedboth with the
growth in import licensing,the collapse in oil prices and the resultant
devaluationof the Rupiah in 1983. The large proportionatefall in imports of
capital goods relativeto intermediategoods between 1983 and 1986 reflects
tLe decline in investmentand overall economicactivity. The adverse shock of
the oil price decline severelyreduced investmentplans, in both the public
and private sectors,while reducingimports of intermediategoods for existing
projectsby a lesser proportion. Since 1986, the partial deregulationof
imports and the recoveryof private sector investmenthas been accompaniedby
increasedcapital and intermediategoods imports. In addition,the boom in
 - 27 -

exports since 1986 has stimulatedinvestmentand the usage of intermediate

imports. These positive effects have more than offset the demand reducing
effect of the 1986 devaluation. It shculA be noted that most of the trade
deregulationto date has focussedon loweringthe price of capital and
intermediategoods and improvingthe access of exportersto importedinputs.
The relativelylarge falls in imports of consumer goods in the period 1983-86
and the failure of this categoryto recover in the period 1986-88 are
consistentboth with the fall in income due to the oil shock, and with the
fact that this is probably the area in which there has been least
deregulation.

Exports

1.44 The most strikingfeature of Indonesia'ssuccessfuleconomic

adjustmenthas been the growth of non-oil exports,which increasedfrom
US$3.9 billion in 1982183 to US$12.1 billion in 1988/89. This growth more
than made up for the decline in export earningsfrom oil and LNG, which, over
the same period, fell from US$14.7 billion to US$7.7 billion. As a result,
the share of non-oil exports in total exports rose from 21 percent in 1982/83
to 61 percent in 1988/89 (see Table 1.14). It is also encouragingthat during
the second stabilizationthe strongestgrowth in non-oil exports period has
been across a wide range of manufacturedproducts.

1.45 This strong performancehas been underpinnedby the continuedrapid

expansionin manufacturedexports,which grew at an averaged 34 percent per

Tab1& 1.14a GROWTH IN EXPORTS 1983 - 1988

Value of exports
current prices, Real growth rates (Z p.a.)
US$ billion 1982 1986 1987
1982 1988 1986 1987 1988

MerchandiseExports 18.6 19.8 9.4 6.5 7.5

Non-oil exports 3.9 12.1 13.6 25.8 13.6
Oil and LNG 14.7 7.7 6.5 -8.9 0.8

Non-Oil Exports
Agricultural 2.4 4.6 7.3 15.0 3.7
Hinerals & metals 0.7 1.4 9.9 15.0 -3.5
Hanufactures 0.9 6.1 33.8 42.6 27.1
Textiles 0.2 1.8 42.0 50.9 26.5
Plywood & panels 0.3 2.0 35.5 29.5 10.4
Other 0.4 2.3 27.1 51.9 45.2

Source: BPS and BI data.

 - 28 -

year in real terms over the period 1982/83 to 1988189 and was diversified
across a wide range of sub-sectors. Of particularnote is the 47Z real growth
in the wide range of productsgrouped togetherunder 'other'manufactured
goods during the second stabilizationperiod. The largest absolute increases
have been in textiles and plywood: export growth in these sectors taken
togetherhas added about US$3.0 billion to the absolute increasein
Indonesia'sexport earningsover the period 1982/83 to 1988/89. However, the
absolutecontributionof "othermanufacturingindustries'has been larger than
the individual contributions of either of plywood or textiles. Over the
period 1982-88,exports by other manufacturingindustriesgrew by almost
US$1.9 billion, from US$0.4 billion to US$2.3 billion.

1.46 Many of the large absolute increasesin exports by "other"

manufacturingindustrieshave been from very small bases. As a result,many
of these industries have gro .n at very rapid percentage rates: dollar
earnings from exports of plastics;ceramics; glass; basic metal products;
shoes; furniture;paper products; and rubber productshave all grown by more
than 80 percent per year during the period 1985 to 1988. The very rapid
growth of a wide variety of manufactured exports has been a remarkable
achievement. The one negative aspect of this achiavementis that a part of
the growth in manufacturedexports, if only a small part, has been due to
export bans and/or taxes on unprocessedprimary products, such as logs, raw mm
rattan and low grade rubber.22/

1.47 Two recent econometricstudies have tried to decomposethe surge in

non-oil manufacturedexports into two components: (a) the response to the
depreciationin the exchangerate; and (b) the responseto other changes in
the trade and regulatoryframework.23/ Both studies concludethat the strong
growth in non-oil exports during the second adjustmentperiod (1986-88)cannot
be fully explainedby the change in the real exchange rate alone. While
estimatesof the size the additionalgrowth in non-oil exports due to
deregulationvaries between the two stL4ies,it would appear that there has
been a structuralbreak in the growth of manufacturedexports which partly
reflectsthe effect of a more open trade regime and domesticregulatory
framework. As firm level interviewsconfirm, the most import componentsof
the deregulationreforms have been the removal of import NTBs, the
introductionof SGS to process and certify imports,increasedcompetitionin
shipping,and the BAPEKSTAfacility. These have led to increasedutilization
of existingcapacity and a surge in both domesticand foreignprivate
investment in export orientedactivities.

22/ The effect of the ban on low grade rubber is minimal as SIR-50 rubber
accounts for about 0.4? of Indonesia'srubber exports. The concern
here is that this is the beginning of a move to restrictall forms of
semi-processed rubber.

23/ G. Fane, "Econometric estimatesof determinantsof non-oil exports in

Indonesia"- backgroundpaper, 1989; and D. Wheeler and J. Harris
"EconomicIncentivesand the Growth of IndonesianManufacturedExports
between 1977-1988,An EconometricAnalysis."
 - 29 -

1.48 Finally it is importantto note that Indonesia'sstrong export

performanceis reflectedin rising - but still modest - shares in world
markets. Since a low point in 1982, the share of Indonesia'snon-oil exports
has risen in both world trade and in the exports of the fast growing Asia
region, and Indonesianow accounts for about 1.32 of total world exports.
Although manufactureshave been the most rapidly growing component,
Indonesia'sshare in world exports of manufacturesis still small at an
estimated 0.42 in 1987 (comparedwith 0.12 in 1980). Only in textilesand
plywood does Indonesia account for a significantproportionof world
manufacturedexports.

1.49 In relationto other countriesin the region the ratio of Indonesia's

manufacturedexports to GDP has been low, but has expandedquickly since 1986
(see Table 1.15). After hoveringaround 7.02 of GDP in the early 1980s, the
ratio of exports to GDP began increasingin 1986 and had doubled to 152 by
1988. In terms of the directionof Indonesia'smanufacturedexports,Japan and
the EC have been the most buoyant markets in recent years, but even here
Indonesia'sshare of manufacturedimports into these countriesis only 1.0Z.
This is consistentwith the view that for most of its emergingexports,
Indonesiacan continueto expand rapidlybefore market share becomes a binding
constraint.

Table 1.15: SELECTEDCOUNTRIES: EMPORTIGDPRATIOS, 1980-88

Indonesia Thailand Malaysia Philippines India Nigeria Turkey

Total Non-oil Total Non-
and gas oil

1980 26.7 6.8 20.2 52.8 16.3 5.0 28.5 1.1 5.0
1981 22.7 4.5 20.1 47.0 14.6 4.5 19.4 0.6 8.1
1982 18.8 4.0 19.5 44.9 12.5 5.0 14.4 0.3 10.9
1983 25.3 6.9 16.1 46.8 13.9 4.5 11.8 0.5 11.1
1984 24.6 6.9 17.9 48.5 15.9 4.7 13.0 0.4 14.2
1985 21.9 7.3 19.1 49.4 14.0 4.3 14.2 0.4 13.0
1986 19.2 9.4 21.2 50.2 15.5 4.1 9.6 0.6 12.8
1987 25.6 13.3 24.5 56.0 16.4 4.5 28.1 2.8 15.0
1988 25.1 15.3 28.7 60.9 17.9 4.8 24.6 3.6 16.6

Source: InternationalFinancial Statistics,and staff estimates.

Manufacturingand Employment

1.50 As the manufacturingsector has been the primary target of the move
towards a more open trade and regulatoryframework,one would expect the
effects of reform to registerin this sector fir6t. Table 1.16 shows recent
trends in aggregatevalue added togetherwith a more detailedpicture of
 - 30 -

employmentfor all large and medium scale industries. The data shows that
while the rate of growth in value added has acceleratedover all the
sub-periodsbetween 1975-88,the rate of growth in employmentvaries
significantlybetween the two stabilizationperiods. The faster rate of
growth of manufacturingemploymentin the second stabilizationperiod reflects
a switch in resourcesboth between and within sectors towards those labor
intensiveactivitiesin which Indonesiais internationallycompetitive.

1.51 During the first stabilizationperiod the increasein the growth in

value added (from 10.4Z p.a. between 1975-82 to 15.42 p.a. between 1982-85)
reflectsthe commissioningof several large capital-intensiveplants in the
iron and steel, pulp and paper and chemicals sectors. Value added in these
sectors expandedat an average annual rate of 392, 332 and 192, respectively,
during 1982 to 1985. However,because their labor intensitywas low, the
overall level of employmentgrowth in manufacturingslowed from an average
6.12 p.a. over 1975-82, to 5.1 over 1985-88. During the second stabilization
period the further accelerationin the rate of growtk-in valued added (to
18.32 p.a.) has been supportedby a marked increasein the rate of growth in
emDloyment (to 9.92 p.a.). The most significantincreasein the rate of
growth in value added during this period has been in textiles (from 112 p.a.

Table 1.16: GRO1TN IN VALUE ADDED AND D4PLOINENTIN LARGE

AND NDIUK
IA( UFACTURNG
1975-1988

2 p.a. Labor
1975-82 1982-85 1985-88 Intensity /a

Value Added 10.4 15.0 18.3

Employment 6.1 5.1 9.9 1.0

Food processing 2.8 4.3 5.3 1.0
Textiles,etc. 5.3 4.2 13.9 1.8
Wood products 17.4 12.4 16.7 1.2
Pulp & paper 6.5 6.1 15.7 1.0
Chemicals,rubber & plastic 6.3 5.0 10.6 .8
Glass & ceramics 9.8 7.2 5.2 1.0
Iron & steel 26.7 7.8 5.8 .2
Engineering 9.8 1.3 5.5 .7
Other 13.2 5.9 16.6 1.0

/a Labor intensityfor each sub-sectoris defined as the ratio of the

sub-sectors'share in total manufacturingemploymentto its share in
total manufacturingvalue added.

Source: BPS. Preliminaryreestimatesof manufacturingoutput and employment

for large and medium scale manufacturing.
 - 31 -

in 1982-85, to 23Z in 1985-88),with pulp and paper, wood products, food

processingand 'other'manufacturingproductsalso performingstrongly. All
these sectors have an above-averagelabor intensityratio. The exceptionsto
this trend towards relativelylabor intensiveexport oriented industrieshave
been in the iron and steel and engineeringsectors. In the case of steel,
this reflectsthe commissioningof the cold rollingmill, whereas the
engineeringsector has continuedto receive a high level of protectionfrom
imports relativeto other manufacturingactivities.

1.52 The strongergrowth in manufacturingoutput and employment (in the

second adjustmentperiod) can be attributedto three closely related factors.
First, the depreciationof the real exchangerate and the resultingdecline in
the world price of Indonesianmanufacturedexports has stimulatedexport-led
growth. Second, the deregulationof imports and the introductionof the
BAPEKSTA facilityhave increasedthe price of exports relativeto imports,
reorientingthe manufacturingsector away from its relianceon a highly
protectedbut relativelysmall domesticmarket. Third, the change in relative
prices coupledwith the relaxationof investmentrestrictionshas encourageda
marked increase in foreignprivate investment.
 - 33 -

CHAPTER 2

THE CURRENT TRADE REGIME

A. Introduction

2.01 As outlinedin Chapter 1, the deregulationmeasures taken since 1985

have significantlyimprovedtrade policy related incentives. The incidenceof
NTBs on importshas been cut by half, reestablishinga direct link to world
prices and, in many cases, reducingthe level of protectionafforded domestic
producers. In addition,exportershave been providedwith a mechanism to
access importedinputs at world prices which representsan importantstep
towards a more neutral trade regime. Despite this progress,the trade regime
still hampers the efficientallocationand use of domesticresources as well
as taxes domesticconsumers. Largely due to the effects of the import regime,
the pattern of incentivescontinuesto provide high protectionto
manufacturingrelativeto agricultureand favors productionfor the domestic
market over exports. Although export assistancemeasures reduce the overall
anti-exportbias of the trade regime,their effect is partial, leaving many
potential economicactivitiesand the losses incurredby consumersuntouched.

2.02 To understandwhy the trade regime continues to produce this pattern

of incentivesit is necessaryto review the individualpolicieswhich comprise
the trade regime. This Chapter addressesthis issue by providing a detailed
discussionof the major trade policy instrumentsand highlightingwhich
sectors are most effected. With respect to the import regime, two policy
instrumentsdominate;the RestrictedGoods List (NTBs) and the import tariff.
Despite the significantprogresssince 1986, NTBs remain the single most
importantpolicy related distortionin the trade regime. About a third of
total domesticvalue added remainsprotectedby NTBs, with coverage in the
food crops, processed food and beverages,baLic metals, and engineering
sectors being particularlyhigh. With respectto import tariffs, their
importancehas increasedin direct proportionto the removal of NTBs.
Although the tariff reform of 1985 reduced the average tariff level, current
statutorytariffs are high and there is a wide dispersionin tariff rates. In
addition,a number of ad hoc adjustmentsin the tariff schedulehave occurred
as a result of the deregulationpackages,includingthe introductionof a
number of surchargesand "split-tariff"positions. As a result there has been
a slight increasein both the average level and dispersionof tariff rates
since 1988, which has lost the momentum towards lower and more uniform tariffs
establishedin 1985.

2.03 Export policies fall into two categories;those designed to regulate

export trade and those designedto assist exporters. Export regulations
(bans, quotas, taxes, approvedexporterand quality controls) are focused on
agriculturalgoods and have recentlyshown a worrying trend towards
encompassingmore products. Export assistancemeasures (the duty exemption/
drawbackscheme, export credit, and export insurance)are primarilyused by
producersof manufacturedgoods. They have played an importantrole in
 - 34 -

facilitatingthe current non-oil export boom by circumventingthe price

distortionscreated by the import regime.

B. The ImpvortRegime

2.04 The import regime comprisesof two policy instruments: (a) the
RestrictedGoods List - which limits the right to import listed commoditiesto
holders of a particulartype of license,thereby creatinga non-tariffbarrier
(NTB) to trade; and (b) the Import Tariff Schedule- which fixes the statutory
import duty (BM) and import surcharge(BMT) for importedgoods. These two
policy instrumentsplay the dominantrole in shaping the incentiveeffects of
Indonesia'strade regime.

The RestrictedGoods List

2.05 All imports into Indonesiaare classifiedunder a particularlicense

category. In order to import any product an importermust possess the license
under which that product is classified. As shown in Chapter 1, most of
Indonesia'simports are classifiedunder the non-restrictiveIUIIU+ (Import
Umum or General Importer) license. To obtain an IU/IU+ license an importer
presents a business permit and tax payers identificationnumber to the
Ministryof Trade and pays a small processingfee. There are over 3,000 IU
licenseholders and interviewswith the private sector indicatethat they are
easy to obtain. There are, however, over 900 productswhich cannot be
importedby holders of an IU/IU+ license. These productsare listed on the
"RestrictedGoods List", and can only be importedby holders of the license
under which the commodity is classified. The RestrictedGoods List accounts
for about 212 of total import value and, more importantly,292 of total
domesticproduction.

2.06 Aside from import bans, there are basically four types of license
categoriesunder which restrictedgoods can be classified. These are the:

o IP (ImporterProducer) license,which is available to those domestic

producerswho use IP items as inputs into their productionprocess
and can demonstratethat domesticsuppliersof the same input cannot
meet their price/qualityspecifications- e.g., fabric for garment
manufacturers.

O AT (Agent Trader) license,which restrictsthe right to import AT

items (mostlyheavy machinery)to the sole agent of selectedforeign
suppliers- e.g., bulldozerscan only be importedby the appointed
sole agent of a designatedforeign suppliers.

O IT (ImporterTrader) license,whiciarestrictsIT items (mostly

consumer food and beverageitems) to the six State Trading Companies
(STCs)l/; and

1/ These are Dharma Niaga, Tjipta Niaga, Mega Eltra, Pantja Niaga, and
Kerta Niaga, Sarinah Persero.
 - 35 _

o PI (ProducerImporter)license,which restrictsPI itemsto domestic

producersof the sameproductor to a designatedsole importer(e.g.,
some importedsteelproductsare restrictedto the majordomestic
steelproducer,and the major importedfoodproductsare restricted
to BUJLOG).
2.07 The sectoraldistribution goodsacrossthe four
of the restricted
basiclicensetypes,togetherwith the bannedand unknownitems,are shownin
Table2.1. The tablealso showsestimatesof the currentproportion of
domesticproductionthatis protectedfromimportcompetition due to these
licenserestrictions.The degreeto which the differentlicensecategories
restricttrade (i.e.,the heightof the NTB)variessignificantly,as
explainedbelow.

Table 2.1: DISTRIBUTIONOF PRODUCTSINCLUDEDIN TUE RESTRICTED

GOODSLIST. BY LICENSETYP AND SECTOR

Four LicenseTYDeS Un- NTB

Description IP AT IT PI/aj BannedknownTotalCoverage/b
C)

Food,beverages& tobbaco 0 0 5 233 0 55 293 67

Chemicals,rubber& plastic 3 0 13 4 0 45 65 15
Testiles,clothing& leather 18 0 254 2 0 0 274 25
Non-metalproducts 0 0 4 0 0 1 5 17
Basicmetalproducts 16 0 3 30 0 0 49 23
Engineeringand vehicles 65 70 62 0 18 3 218 53
Othermanufacturing 3 0 7 0 0 0 11 25
Total 105 70 348 269 18 105 915

la Includesthoseitemsrestrictedto KrakatauSteel(KS),BULOG,selected
StateTradingCompanies(STCs),PERTAMIRA,
and DANANA.
/b Percentof domesticsalesprotectedfrom importcompetition
via the
RestrictedGoodsList.
Sow.ce WorldBank staffestimatesand Ministryof Trade.

2.08 The importban and the AT and IP licensecategoriesare used

collectivelyto encouragethe domesticproduction of mechanicaland electrical
machinery,particularlyvehiclesand heavytransportequipment.The 18 banned
itemscovermotorvehicles,trucks,motorcycles,televisions, and radios,all
in theirCompletelyBuilt-up(CBU)form. With few exceptions, theseitemscan
onlybe importedunderan AT license(in the CBU form)or, more commonly,
underan IP license(as a completely knocked-downkit, CRD). The AT license
 - 36 -

category is uisedexclusivelyfor engineeringand transportequipment in its

CBU form.2/ By allowing only a restrictednumber of foreign suppliers (i.e.,
selectedbrand-names)access to the Indonesianmarket, GOI hopes to encourage
these suppliersto make a long-termcommitmentto provide back-up services,in
terms of repair and spare parts. A suppliermay also be encouragedto
graduallyestablisha local assemblyplant or spare part manufacturing
capacity. If a supplierprovides such a commitmentthe AT license is then
granted to an agent who will have the sole right to import a particularbrand
name.3/ For example,if it is decided that there will be two suppliersof
mechanicalshovels,a sole agent will be appointedfor each brand name.
Although this policy may have benefits, in terms of reducingthe variability
in maintenanceand spare part needs, it also has costs associatedwith the
absence of competition. Designatedsuppliershave access to a highly
protected domesticmarket, allowingthem to price their products above world
levels. It is also limits choice, as the designatedAT suppliersmay not be
able to provide the particularpiece of equipment requiredby the Indonesian
user.

2.09 The IP category covers most of the products under the AT licensebut
in their CKD form.4/ Producersof these items are granted an IP license
specifyingthe total value of the IP items that they can import, including,in
some instances,a timetableindicatingwhen they should reach a certain
proportionof "local-content".Thus, there is a direct link here between the
trade regime and the domestic regulatoryframework,particularlythe deletion
or local-contentprogram. The primary objective is to encourage local
assemblyof mechanicaland electricalmachintry, includingthe use of local
components. Although producersare allowed leeway to source the necessary
componentsfrom the cheapest supplier,the end result is often costly and poor
quality machinery,producedbehind high protectivebarriers from foreign
competition. The IP licensecategoryalso includes some textile and steel
items.5/ The primary objectivehere is to protect the domesticmanufacturer
of the IP item, while at the same time allowing some downstreamusers access
to imports. This is used particularlyfor those industriesgeared to the
export market where price and quality considerationsare vital. As the IP
licenseholders are allowed to import only the quantity they require (i.e.,
they are not allowed to sell the importedIP item to other users), the
domesticmarket is still highly protected. Besides taxing domesticconsumers,

2/ The most importantproductsare engines,boilers,mechanical

excavators/shovels,electricfurnaces,locomotivesand some types of
motor vehicle.

3/ The appointedsole agent (e.g., for Caterpillar)can appoint other sub-

agents to sell this brand on the Indonesianmarket. This is to enable
the sole agent to servicedifferentparts of Indonesia.

4/ These includeCKD engines for tractors/cars,CKD road rollers and road

making equipment,CKD electricmotors, CKD telephonesets, mechanical
spare parts, and pistons.

5/ The textile items are primarilyman-made fabrics. The steel items are
basic steel products (ignots,billets, slabs, sheet and plate) plus
some semi-processedproducts (selectedtubes, pipes and rods).
 - 37 -

the current system creates uncertaintyfor downstreamproducers due to the

administrativediscretioninvolvedin determiningwhether they will be granted
an IP license or not.

2.10 The IT license category restrictsimports of all IT items to the six

State Trading Companies (STCs). For some products, the Ministry of Trade also
determinesthe amount which the STCs can import. There appears to be two
objectivesunderlyingthe IT licenses (i) by restrictingimports to STCs, the
Ministry of Trade can (via informalquotas) control the quantityimported;and
(ii) it provides a steady source of business to the STCs. As shown in
Table 2.1, the IT license covers a wide range of productsacross all sectors.
For example,the 254 textile items classifiedunder the IT licensecategory
covers all types of batik fabric and clothing. As the STCs have been informed
not to import batik products (to protect the local industry),this is an
extreme example of how the informalquota system can work. Other products
which fall under the IT licensecategory include: agriculturaltools (hoes,
scythes, rice hullers),some electroniccomputerequipment,telephonesets,
transmitters,navigationsets, electronicrecordinginstruments,salt,
bandages, and some fertilizertypes. The non transparentway by which the
level and allocationof quotas is determinedcreates opportunitiesfor abuse
and could lead to an inefficientdistribution. Even where quotas do not
exist, the end result is often to increasethe domesticprice of these items
to users, while protectinglocal producers (where these exist).

2.11 The PI licensecategory is potentiallythe most restrictivein that

it restrictsa fairly wide range of productsto designatedimporters,many of
whom are domestic producersof the same product. For example, 25 steel
products fall under the KrakatauSteel (KS) license,which restrictsthe right
to import these items to the state-ownedKrakatauSteel Company. As defined
here, PI also includesthose items restrictedto particulardomestictraders,
such as BULOG or selectedSTCs. Table 2.2 provides a more detailedpicture of
how the 269 PI items are distributedby product and by designatedimporter.
The items restrictedto K:akatau Steel/TambangTimah (KSITT)and BULOG are the
most important,in terms of domesticproductionand import value. Although
many steel productshave been deregulated,approximately231 of this sector's
output remains protectedby NTBs. These include steel coils, sheets and
plates (particularlycold-rolledproducts)and tin plate which are restricted
to Krakatau Steel, and aluminumplates which are restrictedto Tambang Timah.
Although the situationhas improvedmarkedly since the mid-1980s,domestic
users of these products still complainof high prices, poor quality and
uncertain delivery.

2.12 BULOG holds the import rights for many agriculturalcommodities,the

most importantof which are rice, wheat, wheat flour, sugar, soybeans,and
soybean meal. These products account for over half the value of Indonesia's
food imports. With the exc'ptionof rice, the domesticprice of these
commoditiesis usually significantlyabove world prices. This has taxed
consumersand reduced the competitivenessof downstreamusers in the food and
beverage industry. In terms of the number of items, the majority of PI items
(mostlyprocessed food and beverageproducts)are restrictedto two of the six
 - 38 -

Table 2.2: DISTRIBUTIONOF 'PI' LICENSE ITDNS BY IMPORTERAND PRODUCT

Description TNIKN KS/TT BULOG Other Total

Food & Beverages 204 18 11 233

Meat, fish and dairy product 28 6 34
Edible vegetablesand fruit 46 2 48
Coffee, tea, mates and spices 2 2
Cereals & milled products 11 13
Processed food products 97 7 1 105
Beverages,spirits and vinegar 33 33
Chemicals 4 4
Mineral fuels, oil 2 2
Explosives 2 2
Textiles 2 2
Jute 2 2
Basic metals 30 30
Iron and steel 25 25
Aluminum 5 5
TOTAL 204 30 20 15 269

Notes TNIKN - PT Tjipta Niag&, PT. Karta Niaga (STCs).

KSITT - PT KrakatauSteel, PT. Tambang Timah.
BULOG - Badan Urusan Logistik.
Other - IncludingPertamina,Dahana, Mega Eltra.

Source: World Bank staff estimatesand Ministry of Trade.

STCs - i.e., Tjipta Niaga and Karta Niaga (TNIKN). As in the case of the IT
license,TNIKM may be allocateda quota by the Ministry of Trade determining
the total value of the importeditem that will be allowed. In some instances,
TN or KN may sell the right to import these items to private companies for a
set fee. Finally,the items grouped under motherscover a mix of products,
includingoil (restrictedto the state oil company,Pertamina),explosives
(restrictedto the state ammunitioncompany,Dahana), and a range of food and
beverage products (restrictedto particulardomestic trading companies).

2.13 The 105 products listed under the *unknown'categorywere includedin

the 1988 RestrictedGoods List but have proved difficult to classifyunder any
license type. This may be due to identificationproblemsarising from the
recent switch to the HarmonizedSystem (HS) of classifyingtraded goods or it
could reflect the lapsingof certain restrictions. Whatever the reason, the
uncertaintyconcerningthe license status of these products illustratesone of
the problemsassociatedwith allowingtrade restrictionsto be both imposed
and removed in a piece-mealfashion,through a series of degrees. One of the
problems of Indonesia'scurrent trade regime is the ambiguityconcerningwhich
trade restrictionsor tariffsapply. As discussedin subsequentchapters
 - 39 -

there is a need to provide a definitivelisting of the existing regulatory

frameworkas one componentof the overall deregulationeffort.

The Tariff Schedule

2.14 In January 1989, Indonesiaconverted from the CCCN classification

system (about 5,500 tariff positions)to the new HarmonizedSystem (about
9,000 base tariff positions).6/ In making this conversion,the intentionwas
to leave the basic structureof the tariff scheduleunchanged. However, the
Governmentdid use the opportunityto reduce the number of tariff positions
with specificduties from 498 under the 1988 CCCN scheduleto 19 in the 1989
HS schedule. As discussed in Chapter 1 (see para 1.21) this has improvedthe
transparencyof the tariff scheduleand, in most cases, lowered the effective
tariff rate. Unfortunately,the positive effects of this reform have been
more than offset by the increasedprevalenceof usplitu tariff positionsand
surcharges. Although the originalHS scheduledid not contain any split
tariff position, a series of decrees since January 1st, 1989, have
reintroduced592 splits. As a result, the number of effectivetariff
positions is now 9,662 comparedwith 9,070 in the originalHS schedule
(see Table 2.3). In addition, the number of items with surchargeshas
increasedfrom 180 in mid-1988 to 376 at the present time.71 The overall
result of these developmentshas been a slight increasein the average
weighted tariff and a more significantincreasein the dispersionof tariff
rates.

2.15 With referenceto the basic ad valorem tariff schedule,there are 12

different ad valorem rates, ranging from 0? to 200? per cent. Most items
(99?) are below the officialtarget tariff ceiling of 60Z. The most frequent
rates are 5Z, 30S and 602, with just over half the tariff positions accordeda
tariff rate of less than 20Z. There are 19 items to which a specific rate
still applies,all of which are certain types of rubber tyres and inner tubes.
The estimatedad valorem equivalentrate for these items is between 50? to
360Z.8/ These estimatesclearly illustratethat specific rates can provide
high and disparatelevels of assistance,and that by their nature they do not
easily reveal the extent of assistanceprovided.

2.16 The 376 surchargeableitems attract rates that range from 5? to 40Z,
with the most frequentrates being 30, 20, and 5. About half of the
surchargesare set at 30? and almost all surchargesoccur within manufacturing
(see Table 2.5). The greatestnumber of surchargesare within the iron and
steel and food and beverage industries. The highest average surcharge rates
(weightedby production)accrue to tobacco,footwear,beverages,iron and
steel and non ferrousmetals.

6/ This is in responseto a GATT-sponsoredinitiativeto convert all

member countriesto a standardsystem for classifyingtraded goods.

7/ Of these, 130 apply to split tariff positions,43 to the base tariff

positionswhere splits have occurred,and 203 to base items that have
not been split.

8/ Calculatedusing first quarter 1989 import data from BPS.

 - 40 -

Table 2.3s TEE 1989 INDONESIANTARIFF SCHEDULE

AT A GLANCE

Number of basic tariff items 9070

Number of tariff items with splits 413

Total number of splits 592

Effectivenumber of tariff items 9662

Number of items with surcharges 376

Average tariff plus surcharge (X)

Unweighted 27
'Importweighted 12
Productionweighted 19

Source: Customs and ExerciseReport, various governmentdecrees and

informationfrom SGS.

2.17 The average level of tariff protectionwhich results from the current
tariff schedule (includingsurchargesand specificrates) is shown by sector
and broad industrygroup in Table 2.4. Examiningthe unassistedvalue of
productionestimates shows that particularlyhigh assistanceis given to the
rubber industry,primarilydue to the aforementionedspecificrate tariffs on
tires. This is followedfairly closely by ceramic products,weaving apparel,
footwear,wooden furnitureand glass. The next highest levels of assistance
occur within the metal productsand machinery industries,especiallyelectric
machinery. Surchargescause a significantboost to the levels of assistance
receivedin tobacco, footwear,basic metals, and the food and beverage
industry.

2.18 All of the 592 split-tariffpositionsoccur within the manufacturing

sector. As shown in Table 2.5 the majorityof splits occur in the metal
products and machinery industries(402 of the total number) and the basic
metal industry (32Z). In almost a third of the cases, the base tariff item is
split more than once, with some items being split several times (in one case,
 . 41 -

Table8e.4: 18 NAIISS TARIFFSCOEILE9AVERAGE

TARIFF
mPSSU A3 ! RAMTS

ProductionWotahted
Unweighted Import = ;1e un;s_1sid Index of
weighted value value Dispersion

Econom-wido 27 12 22 19 92
Agrtculture 16 6 12 10 74
Mining 6 2 9 9 80
Manufacturing 26 12 80 25 91
Manufacturing * ctor
Food,bevr-n a-tobacco S0 it 29 26 6
Foodmnufacturilng Ili g 1
Bevevare 48 84 40 49 a8
Tobacco S0 48 60 60 87
Textiles,leatherand footwear 46 so 41 37 48
Textilee 17 1 -
Wearingapparel e 657 69 S8 19
Leather product. 24 6 28 28 68
Footwear 71 S1 74 70 81
Wood,corkand product. 80 84 88 88 89
Wood and cork U 15 S
Woodfurniture 47 60 50 50 16
Paperand printing 22 7 21 20 62
Paperproduct. Ug7 U -S
Printingand publishing 18 9 6 4 97
Chemicals,petroland coal 15 6 22 17 140
Induetrialchemicals =1 7 *6 To
Otherchemicals 19 9 8S 33 96
Petroleumrefining 5 0 0 0 63
Petroland coalproducts 6 5 6 6 38
Rubberproducts 41 26 96 87 143
Plasticproductsnec 85 8s 41 41 so
Non-rAetallicindustries 86 9 86 86 64
Ceramicproducts 1! F U
go
Glassand glassproducts 87 17 68 63 84
Other non-metel products 29 7 82 32 69
Basic metal product. 16 7 12 11 121
Iron and steel basic mtal products 17 -7 14 Th
107
Non-ferrous basic metal products 11 7 8 8 121
Metal products and achinery 28 16 46 as 124
Metal product. nec. i2 1! SO U6
Non-electric machinery 14 11 42 40 94
Electricmachinery 28 24 46 43 88
Transport equipment 49 16 56 37 118
Scientific equipment 15 9 19 19 76
Othermanufacturing 86 41 44 43 42
Manufacturd eroducto
Consumergoods 44 27 87 31 66
Intermediate
goode 16 7 18 16 96
Capitalgoods 17 12 89 30 136

Source:Bankstaffestimates.
 462 -

12 times). Comparing the di6tributionof tariff and surchargerates between

the base tariff item and the split tariff item does not reveal any overall
pattern. In most cases the tariff applicableto the base tariff item is
higher than that applicablet% the split tariff item, but this is offset by
surchargeswhich are generallyhigher on the split tariff item.

Table 2.S, INCIDNCE OF SURCHRAMZS MND SPLITS

Number of Items with

Splits Surcharges Splits and
Surcharges

Economy-vide 592 376 130

Agriculture 0 6 0
Mining 0 0 0
Manufacturing 592 370 130

ManufacturingSector

Food, beverages and tobacco 26 91 18

Textiles, leather and footwear 15 25 2
wood,cork and products 1 0 0
Paper and printing 31 36 20
Chemicals,petrol and coal 77 64 11
Non-metallicindustries 9 2 1
Basic metal products 187 127 77
Metal products and machinery 239 24 1

Other manufacturing 7 1 0

Source: Bank staff estimates.

2.19 It is also importantto note that split-tariffpositionshave been

used to keep a particularsize or type of product on the RestrictedGoods List
while deregulatingthe base tariff item. To take a hypotheticalexample, the
tariff position for steel plate could be split, with steel plate of more than
0.2 mm kept under license (probablybecause it is domesticallyproduced)while
steel plate less than 0.2 mm is deregulated.

2.20 The effects that split-tariffpositionshave on the protectionof

local manufacturersare difficultto measure. Separateproductionand import
data are in general unavailablefor split items, so their effect on weighted
tariffs or NTB coverage is difficultto quantify. For example, it is quite
possible that productionis concentratedin the split item with the high
tariff, meaning tbtt splits have resultedin increasedassistance. Splits
also create uncertaintyfor those involvedin administeringthe tariff as well
 - 43 -

as thosein7olvedin importingsplititems. For example,therehave been a

numberof instanceswhen the importerand the governmentagencyresponsible
for certifyingimportshave had difficultyin classifyinga commodity.Thus
while splitsremain,the degreeof assistance providedto industries
cannotbe
fullymeasured. Finally,theygeneratea mechanismfor providing"madeto
measure"assistance,while at the sametimehidingthe natureof the
assistance.
2.21 Anotherimportant characteristic of Indonesia'simporttariff
scheduleis the largeamountof imports(byvalue)thatare exemptfrom import
duty. As shownin Table2.6,actualimportdutycollections rangefrom 3Z to
5Z of totalimportvalue,far belowthe averagestatutorytariffrate- uhich
is currently122. While the averagestatutorytariffdoesnot reflectthose
importtariffsthatare lowerdue to bilateralor multilateral agreements
(mostimportantly ASEANagreements), the shortfallin actualtariffrevenue
collections is primarilydue to exemptions.The majorsourcesof importduty
exemptions ares (a) BAPEKSTA - whichgrantsexemptions on importedinputsused
by exporters;(b) BKPM - whichgrantsimportexemptions on certainimported
capitalequipmentand inputs(for2 yearsaftercompletion of project)for
approvedinvestments; (c) most of the machineryand sparepartsusedby
contractors in the oil and gas industry;(d) the importedcomponentof foreign
aidedgovernment projects;and (e) importexemptions for some selectedfirms.
'Whilethe importduty exemptions providedby BAPEKSTA for exportersis
justified, the otherexemptionschemesmay warrantreview. In somecasesthe
exemptions shouldbe removed, while in othercasesthe Government's objective
may be achievedmore efficiently throughalternative, lessdistortionary, tax
or rebateschemes.

Table2.6: ACTUALIMPORTDUTY REVENUE

to 1988/89,Rps.billion)
(1981/82

1981182 82/i3 83/84 84/85 85186 86/87 87/88 88/89

ActualImport
DutyRevenue 536 522 557 530 607 960 938 1192
TotalImports 12,709 13,906 17,883 16,659 16,114 17,974 23.342 26,567

AverageImport
Duty (Z) 4.2 3.8 3.1 3.2 3.8 5.3 4.0 4.5

of Customsof Excise.
Sources Ministryof Financeand Directorate
 - 44 -

C. The Sport Regime

2.22 Indonesia'sexport regime is comprisedof two types of policy

interventions. First, there are severalexport policiesdeslgned to regulate,
in most cases restrict,the export of designatedcommodities. These are
export bans, quotas, taxes, quality controlsand approvedexporter
arrangements. The government'sobjectivesin regulatingexport trade includes
taking advantage of Indonesia'sperceivedmarket power; encouragingdomestic
processing;and respondingto externallyimposed quotas. Second, there are a
number of measures designedto directly assist exporters. The most important
of these are the import duty exemptionand drawback scheme (BAPEKSTA)and the
provision of subsidizedshort-termexport credit. The objectivesof these
measures are to offset the anti-exportbias created by the import regime and
to protect exporters from the resulting 'high cost economy'.

2.23 In contrast to the progressmade in deregulatingimport regulations,

domesticallyimposed export regulationshave increased. The product coverage
of export bans was broadened in 1988 and the prevalenceof approvedexpotter
arrangementsappears to be spreading. It is estimatedthat 502 of total
non-oil export trade is affectedby some form of regulation,r".th most of
these regulationsconcerningagriculturalor forestryproducts. There has
also been a significantincreasein export assistancemeasures. Almost a
quarter of total non-oil exports use the BAPEKSTA facilityto access part of
their importedinput needs, and about 602 of non-oil exports benefit from
subsidizedshort-termexport credit. As firm-levelinterviewshave confirmed,
these export assistancemeasures have played an importantrole in increasing
the competitivenessof Indonesia'snon-oil exports.

Export Regulations

2.24 The main policy instruments,productscovered and objectivesof

domesticexport regulationsare shown in Table 2.7. Most of the domestically
imposed export restrictionsapply to unprocessedor semiprocessedagricultural
and forestryproducts. In addition,there are three products that are
regulatedas a result of quotas imposed in importingcountries,i.e.,
textiles,tapioca and, until recently,coffee.

2.25 Export bans. Export bans are used primarilyto encouragedomestic

processing (e.g., logs, rattan, rubber, and scrap metal), and/or to protect
scarce resources (e.g., rare animals/plants,live fish, antiques,and forestry
products). In many cases, GOI have adopted a sequentialapnroach,taxing a
product before banning it, and graduallybroadeningthe ban to cover the
product in its more processed form. In the case of rattan, Indonesiamoved
from supplyingover 70? of the world's raw and semi-finishedrattan in the mid
1980s, through a ban on raw rattan, to a ban on all raw and semi-finished
rattan in 1988. One effect has been a decline in the domesticprice of raw
and semi finishedrattan relativeto world prices. This has reduced the
revenue to raw rattan growers/collectors(most of whom are lower paid workers
in the outer islands) and increasedthe revenue to .attan product
 - 45 -

manufacturers(most of whom are in urban centres). The world price of rattan

has also increased,which has benefittedproducers of raw rattan in other
countries and raised the incentiveto smuggle. While the comparativelylow
cost of rattan in Indonesianhas led to increasedinvestmentin the production
of rattan products, it is not clear that the economy as a whole has benefited.
The full economic costs of producingrattan products - includingthe losses
imposed on raw rattan producers - needs to be taken into account in
determiningthe net economicbenefit. In addition, the longer term effects of
the ban need to be considered. Although Indonesia did supply most of the
world's raw rattan, foreignproducers of rattan products have now begun to use
alternativesources of supply (e.g., from Burma, Vietnam, China) and there has
been an upsurge of investmentin raw rattan productionin other countries
(e.g., in Malaysia). The likely consequencesof an export ban are discussed
further in Box 2.1.

2.26 Export bans are also used to protect Indonesia'sscarce natural

resources. For example,the ban on log exports has been related to the need
to slow the rate of forestrydepletion. While the ban did result in an
initial decline in log production,the subsequentrapid growth in the domestic
plywood industryhas reversedthis trend. In addition,other environmental
problemshave resultedfrom this policy. For example, there have been
difficultiesensuringthat plywood factoriesinstall appropriatewater
treatmentplants to process their waste prior to disposalinto the rivers.
Moreover, the ban on all log types has resultedin some higher value rare
woods being processed into plywood, reducingthe returns to the economy. Thus
environmentalconcernsneed to be addressedin a more comprehensivemanner.
In this instance,it is the total domesticproductionof logs (and other
forestryproducts)which is the issue, and not the productionfor export.

2.27 Regulatedexports. Many of the products in which Indonesiahas a

significantmarket share are restrictedto 'approved'or 'registered'
exporters. In terms of value, it is estimated that 5O0 of all food exports
are regulatedunder this system. Exports of textiles,some mineral products
and petroleumproducts are also channeledthrough approvedexporters. The two
main objectivesof the approvedexportersystem are to coordinatedomestic
suppliers/tradersto enable them to make the best use of Indonesia'smarket
position, and, in the case of externallyimposed quotas (i.e., textilesand
tapioca),to distributeand monitor quota allocationsefficiently. To obtain
an approvedexporter license requiresapprovalby the Ministry of Trade, and,
where applicable,the Ministry also stipulatesthe export quota allocation.
The number of approvedexportersfor any given commodity is usually limited,9/
and is often set in close collaborationwith the relevant commodityTrade
Association. Finally,the Ministryof Trade can also authorizethe
establishmentof a Joint Market Office (MO', to market certain products. All
productsproducedon state plantationsar'~:arketed through JMOs, including
coffee, cocoa, rubber, tea, and crude palm oil. JMOs have also been
establishedfor nutmeg and cassia vera.

9/ For example,there are an estimated330 approved exportersfor coffee,

43 for nutmeg and maze, 38 and 45 for white and black pepper
respectively,and 50 for cassia vera.
 - 46 -

Table 2.7: EXPORT RESTRICTIONS

1. EXPORT BANS

Objectives: Conservescarce resources,encouragehigher value added,

increaseemployment,preservation.

Goods: Low grade rubber, rare live fish, shr'mp fry, iron and steel
scrap, logs, raw skins and hides, fancy wood, rav art semi-finishedrattan,
remilledand smoked rubber, brass and copper 'crap, sawn ramin and other
boards, green veneer, rare animalsiplants,antiques,kapok seed.

2. REGULATEDEXPORTS

Can only be exportedby approvedor registeredexporters.

Objectives: To respond to an internationalquota, or to avoid

"counter-productive"
competitionbetween Indonesianproducers.

Goods: Vegetables,nutmeg/mace,coffee, tengkawangseed, cassia

vera, textiles,plywood, sawn wood, processedwood, tin, petroleum oil and
liquid natural gas, gold, silver, rattan mats.

3. SUPERVISED EXPORTS

Can only be exportedwith approvalof Minister of Trade or officials

authorizedby Minister.

objectives: to ensure sufficientsupply to meet domestic

requirements.

Goods: Salt, wheat flour, soyabean,rice, live animals, fertilizer,

kapok seed, newsprint,palm oil, palm kernel oil, coconut oil, copra, palm
kernel, Bandeng fry of all sizes.

4 EXPORT TAX

Exportersmust pay export tax (PE) and where applicablean additional

export tax (PET). Por some commoditiesthe tax is calculatedon the basis of
a published check price, not actual FOB.

Objective: Tax revenue,low domesticprices.

Goods: Pepper, palm nuts, tengkavangseeds, chinchonabark, metal

ores, leather,cork, aluminumwaste and scrap, sawn timber.

Sources Departmentof Foreign Trade.

 - 47 -

Box 2.1: EFFECT OF AN EXPORT BAN

Dd

w C__ _ _ _ _
consumer, Dead Weight Loss

Pd I Dw

Qd Qdb Qt= Qd+ Qw

Dd = DomesticDemand Curve
Dw = World Demand Curve
SS - Domestic Supply Curve

Before the impositionof the ban, domesticproducers sell at price

PW and supply quantityQt, where Qt is determinedby world demand
(Qw) plus domestic demand (which is Qd at the prevailingworld
price). After the impositionof the ban, the domesticprice drops
to Pd and total output declinesto Qdb. As a result, revenue to
producers falls from Qt x Pw to Qdb x Pd. Domesticproducers incur
a net loss of the area PwABPd. This loss can be divided into two
parts: "ConsumerGain" and "Dead Weight Loss". Domesticusers or
consumersof the banned product gain a transferof income equal to
the area PwCAPd, due to the decline in domesticprices. The
remainingpart of the loss incurredby producersof the banned
product is a 'deadweight loss' for the economy.

j/ If the country imposingthe ban suppliesa significantpart of

world demands foreignproducersof the banned item will also
gain from higher world prices.
 - 48 -

2.28 The actual organizationof exports under the approved exportersystem

varies by commodity. For most of these productsthe role of the trade
associationis central. These associationsoften work with Governmentto
administerthe program and to determinewho receivesor is denied approved
exporter status. In those cases where quotas are allocated,e.g., coffee and
textiles,the associationmay also lobby governmentto direct the allocation
of quotas among their members. Once the initialallocationof quotas has been
made it may be difficult to change. This has led to a system of 'implicit'
quota trading where quota 'deficit'producersbuy the requiredextra quota
from holders of 'surplus'quotas. Although the physicalhandling of the goods
is done by the quota deficit exporter,the transactionoften occurs in the
name of the quota holder. This has created a class of exporters,often
referredto as 'briefcase'exporters,who do not actually export their own
allocations,but maintain their approval status year after year. For example,
it is estimated that almost two thirdn of the approvedcoffee exporters
conductedtheir operationsin this way, with less than 100 physical exporters
out of over 300 approved exporters. Host coffee exports by the state trading
firms are also conducted on a "briefcase"basis. Also many holders of textile
quotas have little if any productivecapacity,and operate simply by selling
quotas.

2.29 In the case of nutmeg and cassia vera, a JMO is responsiblefor

controllingall exports, includingthose producedby private producers. These
JMOs have been created by Governmentdecree as an integralpart of the trade
associationt-.atrepresentsthe industry. The nutmeg JMO is primarily a price
setting organization,issuingnew export prices every month for the different
grades of nutmeg. All approvedexporters (who are also ASPIN members) are
requiredto export:their products at the posted price or face expulsion from
ASPIN and the loss of approvedexporterstatus. Recently,ASPIN told its
members that they could sell to only one buyer, First Pacific Commoditiesof
Singapore. First Pacific Commoditiesis part of the Liem Group, and will be
responsiblefor all internationalmarketing of nutmeg. In the case of cassia
vera, the JMO determinesprices and vho can sell to whom. Thus a foreign
buyer can only place an order with the JMO, and then the JMO determineswhich
exporterwill supply that order. The buyer cannot deal directlywith the
exporter,nor will he know from order to order which exporterhe is dealing
with.

2.30 The problems that arise from the current approvedexporter

arrangementsinclude:

o The administrationand allocationof quotas lacks transparency. This

holds for both externallyand domesticallyimposed quotas. The
Ministry or trade associationresponsiblefor allocatingquotas,
rarely publishes lists of quota holders and the criteria by which
quotas are allocatedare not clear. For example, some textile
exportersthat have fulfilledpast orders have inexplicablyfound
their quota allocationfor the followingyear cut back sharply.
Administrationof the quota allocationscan also be slow, which
causes some individualfirms to miss export opportunitiesand reduces
Indonesia'stotal non-oil export earnings;
 - 49 -

o The allocationof the resultingquota rent may not be in the

industries'or Indonesia'sbest interests. The existenceof a quota
necessarilyproduces a rent and how quotas are allocated determines
the distributionof the rent. For productswhere the trade
associationsare important,currentholders of the quota rights are
often closely connectedwith those that allocatequotas. This
creates the danger that the trade associationswill restrictentry
into the industryor to "approvedexporter" status to protect their
rents. A more open system of allocatingquotas would not only allow
new more efficiententrantsinto the market, but would also clearly
identifywho receivesthe quota rent, and whether this distribution
meets the Government'sobjectives;and

o The current system can result in a level of market power which is

detrimentalto efficiencyand equity considerations. By restricting
the right to export to designatedapprovedtraders, domestic
producers of the restricteditem are denied the opportunityto sell
to alternativetraders or directlyto foreign buyers. This can
result in lower domesticprices,which is likely to reduce investment
incentivesand slow improvementsin quality and production
techniques. While trade associationsare common in other countries,
these are usually voluntary and not enforcedby a governmentpolicy
stipulatingthat all exportsmust be channeled through its members.
Aside from creatinga non-competitivedomesticmarket it also creates
a monopoly supplieron the foreignmarket, which is against GATT
rules.

2.31 Supervisedexports. A number of agriculturalproducts and

fertilizerscan be exportedonly with the approvalof the Ministry of Trade or
an appointedagent. The primary objectiveis to ensure a sufficientsupply of
these productsto the domesticmarket at reasonableprices. In effect, an
informalquota is imposed,which varies in its restrictivenessand how clearly
it is defined for differentproducts. For example, rice, wheat, flour and
soybean can be exportedonly by BULOG in consultationwith the Ministry of
Trade. In practice this has resultedin a negligibleexports,with BULOG
giving primacy to supplyingthe domesticmarket. As imports of these products
are also controlledby BULOG, domesticproducers are completelyisolatedfrom
any direct links to world markets.

2.32 In the case of tree crop products (primarilycrude coconut and palm
oil - CCO and CPO) publicly owned estates market all their output through
JHOs, which then allocatethe CCOICPO between the domestic and foreignmarket.
The overall allocationfor export (includingprivate sector production)is
determinedby the Ministry of Agriculturein collaborationwith the Ministry
of Trade. In the past, the overall export allocationhas varied
significantly,usually moving in the oppositedirectionto world prices. All
exports are then channeledthrough a few approvedexporters.10/ The
non-transparentway by which these export quotas are determinedand allocated,

10,/For example, in 1988 althoughthere were 4 approved exportersit was

estimatedthat over 902 of CPO was channeledthrough one anp,oved
exporter.
 - 50 -

togetherwith the uncertaintyconcerningthe overall level of the quota, has

significantlydiminishedprivate sector incentivesto invest in CCO/CPO
production.

2.33 Export tax. Export taxes are determinedby the Ministry of Finance.
Currently the export tax (PE) is set at rates between 52 to 302, and the
additionalexport tax (PET) is set at either 202 or 302. The combined effect
of these taxes is particularlyhigh for leather (502 to 602) and chinconabark
(502). Specificor lump sum taxes are also levied on some wood products -
these vary from US$3 to US$2,400per cubic meter. For a subset of these
products, the export tax is based upon an estimatedcheck price rather than
the actual FOB price. These check prices are issued by the DirectorGeneral
of Foreign Trade every six months. The objectiveof export taxes is to ensure
an adequate supply of the taxed commoditiesto domesticusers. Check prices
are intended to deter exportersfrom under-invoicing.

2.34 For those productswhere Indonesiahas a negligibleshare of the

world market, (e.g., leather,cork and aluminumwaste and scrap) the primary
effect of the tax is to provide an indirectsubsidy to downstreamdomestic
users at the expense of upstreamproducers. In the case of leather,there is
no evidence to suggest that access to cheap inputs has encouragedthe growth
of the leather footwearindustry. Indeed, the reversehas occurred. That
part of the domestic leather footwearindustrythat is oriented towards
selling on the domesticmarket has stagnateddespite access to cheap leather
and high import tariffs on its output. By contrast the rest of the shoe
industry (i.e., sports and rubber shoes),has shown remarkablegrowth (over
1002 p.a. 1986-1988),using inputs priced at world prices. In this case, the
high export tax has reduced incentivesto local leather producers to invest in
the machinery required to produce the type of high quality leather demanded by
shoe manufacturers. In addition to the tax effect, the use of a check price
increasesthe discretionaryelement of the tax, which further reduces
incentivesto invest in the taxed activity.

Export Assistance

2.35 Duty exemptionand drawbackscheme - BAPEKSTAcurrentlyprovides two

mechanismsby which erporterscan access importedinputs free of both import
duty/VATand license restrictions. (i) The Exemption Scheme. To qualify an
exporterneeds to submit a 12 month production/exportplan and, where
applicable,documentationof past performance. If the exporterplans to
export at least 65Z of total output, exemptioncan be approvedfor 1002 of
anticipatedimport needs. If the applicantplans to export less than 652,
exemptioncan be granted on a consignmentbasis linked to specificexport
orders. Once approved,the exporterprovides a bank guaranteeor surety bond,
equal to the value of duties/taxespayable. The exportermay then import the
goods without paying any domestictaxes. When the goods are ready for export
they are inspected by a government appointed surveyor and the guaranteelbond
is retired. Those firms that have been granted 1002 exemption need to submit
a "reconciliationreport' at year end. Duty/VAT is then paid on that
 - 51 -

proportionof output sold on the domesticmarket.ll/ (ii) The Drawback Scheme.

This scheme is intendedto assist indirectexportersby allowingthe final
exporter to obtain a refund of the duty/VATpaid on domesticallypurchased
importedinputs. To qualify,an exporterneeds to verify the import content
of the purchasedgoods and obtain a "waiver"from the domestic supplier
relinquishingtheir right to claim an import duty rebate. The goods must be
inspectedbefore export and a "Clean Report of Findings" issued. BAPEKSTA
will refund 75Z of the duties/taxespaid within one month and the remaining
252 once the export has occurred.

2.36 As shown in Chapter 1 (paras 1.22 to 1.23), the exemption facility

has worked extremelywell. In 1988, approximately82 of total non-oil imports
entered through the scheme, contributingto 242 of total non-oil exports.
Major users of the exemption facilityare manufacturersof food products,
footwear,rubber goods, fabricatedmetals, electricalmachinery,iron and
steel products, chemicalsand plastics - all of which face either high import
tariffs and/or effectivenon-tariffbarrierson some importedinputs.12/
Interviewswith medium and large scale firms confirmedboth the effectiveness
of the exemptionfacilityand the high regard domesticproducershave for
BAPEKSTA'sefficient administration.However, a recent survey of small-scale
export-orientedfirms (less than 20 employees),indicatesthat they benefit
less from the exemption facility. The reasons given include: (i) smaller
firms often cannot order their importedinputs in a large enough volume to
make it attractivefor overseas suppliers (e.g., sugar for processed food);
(ii) small firms are reluctantto disturb relationswith large local suppliers
who may supply other inputs that they require;ard (iii) some of these firms
found the paper work requiredto submit a request to BAPEKSTAbeyond their
limited administrationcapability.

2.37 The duty drawbackfacilityhas been less successful. One of the

major reasons is that final exporters (the major users of the scheme) find it
difficultto document the import content of domesticallypurchased inputs.
Domestic suppliersare sometimesunwillingto provide the 'waiver'which
verifies that import duty has been paid, partly because they do not wish to
reveal their exact import/dutycosts. Also smaller firms find it difficult to
persuade large domesticsuppliersto provide the necessary documentation. As
a result the drawback facilityis primary used by larger exporterswith direct
links to domestic suppliers.

2.38 Export Credit and FinancialGuarantees/Insurance.Short-termexport

financinghas been provided either through pre-shipmentexport financingor
export bill discounting(post-shipment)financing. As discussedin Chapter 2,
the rapid growth in non-oil exports and the 1a; cost of export loans relative
to commercialrates led to a growth rate of 32.52 per annum in outstanding
export credits between 1982 and 1988. The interest-ratedifferentialwith
commercialmoney rates narrowedsignificantly(to a range of 62 to 92) in May

11/ Except for machinery. If any of the incrementaloutput from an

importedmachine is exported,then all taxes on that machine can be
waived.

12/ The estimatedaverage tariff for major items importedthrough the

exemption facilitywas approximately33Z.
 - 52 -

1989, followingGOI's increasein the administeredrates on export loans. The

May 1989 reform also lowered the proportionof bank loan eligible for
rediscountfrom 702 to 402 for primary goods and from 50? to 372 for
nor.-primarygoods. Since the maximum validityof the promissorynote is five
months, banks can obtain funding from Bank Indonesia for a period of up to 150
days only. If the exporter is unable to realize the value specified in the
promissorynote, banks are requiredto reduce the export loan ceiling for the
next turnoverperiod in the same proportionas the export shortfall. The
exportercan either repay the differenceto the bank or renew the same at
commercialinterest rates. The May 1989 changes partly reflect GOI's concern
about misuse and diversionof export loans for purposes other than exports.

2.39 In the Indonesianscheme an exporter can withdraw amounts up to the

loan ceiling approvedby the bank, i.e., the exporterhandles the funds
himself. In a typical export financingscheme,banks disburse funds on behalf
of the exporter in accordancewith actual payment needs. In other words, the
actual payment for the purchase of importedand domestic inputs takes the form
of the handlingbank making paymentsdirectly to the foreign and domestic
supplierof inputs on behalf of the exporter. Only loans for the value added
componentsare made directlyto the exporter,normally after opening of import
and domesticL/Cs. The loan is liquidatedout of the export proceeds as soon
as receivedfrom the foreign buyer. These transaction-based disbursementand
self-liquidatingloan mechanismsminimize the risk of an exporter'sdeliberate
default and misuse or of default stemmingfrom exporters'non-performance.
The condition that the exporteruse a certain minimum of own resourcesfurther
reduces exporter'snon-performancerisk due to mismanagement. The risk
covered by PEFG is much smaller and can be administeredeffectivelywith
reasonableand appropriatepremiums. The scheme also encouragesbanks to lend
to small and new exporters,especiallysince banks are allowed an appropriate
margin for their export activitiesand extend loans at competitiveinterest
rates.

2.40 The most common reason for loan defaultsor market failuresare
adverse selection-- the difficultyin banks' determiningsound
projects -- and moral hazards --- the inability of banks' to assess which
borrowers operate in good faith. These issues prompt banks to require
physical collateral. In the typical trade financingscheme, these issues are
resolvedthrough PEFG and ECI/G. Since disbursementsare transaction-based
and loans are self-liquidating,the adverse selectionand moral hazard issues
related to pre-shipmentloans are substantiallyreduced since only the
value-addedloan componentcarries this risk. Part of the non-performance
risk is covered by collateralcreated by import L/C and domesticL/C and the
self-financingrequirement. The task of a PEFG agency is to provide a
substitutefor collateralto cover the remainingrisk.

2.41 The Indonesiansystem of export financingis based in a large measure

on banks' extendingrevolvingworking capital loans to firms who have
confirmed export orders or plans for the productionor accumulationof goods
for exports.13/ The enterprisescontrol the use of funds after loan limits
have been approvedby the handlingbanks. This system is subject to potential

13/ Plan-basedloans consituteover three-fourthsof total outstanding

export loans.
 - 53

misuse. The system also does not create sufficientcollateralfor the lending
banks. The large differentialin interestrates on commercialloans and
export loans also encouragesmisuse of the export loan whereby funds are
employedby the borrower for purposesother than exports. There is also no
basis for checkingwhether the borrowerhas met the 152 self-financing
requirement. The system not only is subject to potentialmisuse but the
rationingof credit restrictsits use to large direct exporters and is also
more risky. The impact of preferentialinterestrates on export growth has
been insignificanteven where this has been used extensively. Instead,the
emphasis should be on resolvingthe *access"issue, especiallyfor small and
medium-sizedfirms and indirectexporters,rather than on the provisionof
subsidies.

2.42 Viewed from the perspectiveof the lending banks, export loans
rediscountedat Bank Indonesia appear to offer a cheap source of liquidity.
Until May 2. 1989 between 50X and 702 of the loan has been rediscountableto
Bank Indonesia at 32 and banks have held Bank Indonesiacredit to maturity
(180 days) while export loans extendedhad a much shortermaturity.
Nevertheless,banks do not considerexport loans to be very profitable
business as the gross margin between effective lendingand funding rates for
export financingis much lower than the gross spread on other commercial
lending.This has tended to discouragebanks from extendingexport financing
to small and new exporters. In addition,PT. ASEI has indemnifiedlosses
averagingonly about one-third of the claims filed by PEFG users. The low
credibilityof the PEFG scheme implies that it has not acheived its main
objective of providing a substitutefor collateralto assure access to export
financingfor all exporters. Banks in Indonesiado reject loan requestsfrom
potential exporterseven if they have firm export orders. At the same time
they do not guaranteeall export loans with PT. ASEI given their difficulties
with resolutionof claims. This tends to undermine the risk-poolingfunction
of PEFG as well as GOI attempt to prevent pre-rejectionby banks which is the
main reason for the automatic and compulsorynature of PEFG.

2.43 Pre-shipmentExport Finance Guarantee (PEFG). The PEFG cover is

obligatoryfor all exporterswho obtain officiallysupportedexport loans from
the commercialbanks. The PEFG guaranteefee is shared equally by the handling
bank and Bank Indonesia,with Bank Indonesiarebatingits share to the bank
after the bank pays the full amount. The guaranteeis automatic and PT. ASEI
does not review the credit decisionsof the handlingbanks. The amount of
indemnificationis fixed at 85? of the loss sustainedas long as the loss
constitutingthe basis for indemnificationdoes not exceed the credit ceiling.
Bank Indonesia assumes risk for one half of the 152 of the loss not covered by
the PT. ASEI guarantee,while the other half is borne by the lending bank.

2.44 Between 1982 and July 1989, 174 claims were filed , of which 107 were
completelyrejectedand 49 were still in process.Compared to earlier years,
PT. ASEI's responsivenessto claims has shown considerableimprovement. In
*186, PT. ASEI paid claims equal to only 5? of total claims filed and in-
process, and had a backlog of claims in-processequivalentto Rp. 25.6
billion. In 1988, PT. ASEI paid claims equal to 41? of outstandingclaims and
 - 54 -

had worked the backlog of claims down to Rp. 16.4 billion. In the first seven
months of 1989, claims paid equalledonly 202 of outstandingclaims and the
backlog increasedto Rp. 18.7 billion.

2.45 PEFG claims paid by PT. ASEI since inceptionhave averaged222 of

premium income and 342 of claims filed. This does not take into account the
Rp. 62 billion in claims filed by the banks but denied in whole or part by PT.
ASEI. If PT. ASEI had paid all these claims, total claims would have equalled
642 of premium income or 62Z if recoveriesare taken into account. If claims
in-processwere also included,claims paid would equal 76Z of premium income.
This representsa dramaticallydifferentsituationcompared to 1986-87, when
the ratio was in excess of 1002.

2.46 PEFG claim resolution,includingthe amount of documentation

required,the claim scoring system, and the time requiredto settle claims, is
considereda major problem by banks. Even more damaging is the frequent
denial of claims and the practice of paying only part of a claim. The claim
scoring criteriaand the basis for using these criteria are not well known to
the banks. Some of the criteriaused, such as evaluatingthe banks' access to
collateraloutside the stocks and reveivablesrelated to the export loan, are
seen by banks as contrary to the rules for grantingexport financing. The
claim scoring system includesan evaluationof : the initial conditionsfor
grantingof loan by the bank; action taken by the bank to control the loan,
such as periodic inspectionsand credit reviews;exporters'actions that show
the intent to pay; and, possibilityof recovery. To the extent a full score
is not obtainedon any area, the amount of claim paid is reduced accordingly.

2.47 As mentioned above the existingsystem of export financingimposes a

substantialamount of risk on PT. ASEI. This is borne out by an analysisof
the 194 claims filed on PT. ASEI during 19P6-88. About 202 of the claims in
value (54 claims in number) were clearly related to loan misuse and abuse by
borrowers (diversionof funds, false informationand fradulentexport plans,
borrowing from more than one bank for the same transaction,etc.), who
obtained export financingon the basis of productionplans and controlledthe
use of funds rather than having banks' make the payments to the supplierson
their account. The failure rate due to unintentionalmismanagement
(i.e., exportersnon-performance)is also probablyhigher for loans made and
disbursed on the basis of export ' plans' since buyer has not yet been
identifiedat the time of export lean compared to a firm that already has a
confirmed export order or irrevocablebank LIC. Out of the 194 claims on PT.
ASEI analyzed,166 claims (932 of claims in value) were related to the so
called revolving loans granted on the basis of productionplans. Such loans
accounted for 75Z of all export loans in the sample. The remaining72 of
claims in value were related to the 252 of total export loans made on the
basis of export LIC or other firm export order. The risk of exportersnon-
performancehas been more than three times higher for plan-basedloans than
for L/C-based loans.

2.48 The Export Credit Insurance/GuaranteeScheme. The ECI/G scheme

supportsabout one-halfpercent of Indonesia'stotal non-oil/LNGexports. The
number of policies is very small in comparisonto the number of firms in
 - 55 -

export activities,and virtually all policieshave only one buyer in one

country. The limited coveragecontributesto a portfolio that does not
provide PT. ASEI with a reasonablespread of risk between risky and less risky
buyers and markets, and exposes it to potentiallylarge losses relativeto
premium income. Most of Indonesia'snon-oiliLNGexports are traded on sight
LIC terms which results in the low volume of ECI/G business and non-LIC type
payment terms. The requirementthat banks can access liquLditycredits for
non-LIC export transactionsonly if ECIIG has been obtained for the
transactionor the foreign buyer has already paid, encouragessales on sight
LIC terms and discouragesexportersand banks from supportingsales on usuance
LIC or less secured credit terms.

2.49 marketed and is

While the ECIIG program has not been ag&_-essively
little known by the exporting community,risk-aversionon the part of both PT.
ASEI, which frequentlyreduces the amount of cover requested,and the
exporter,who is not interestedin diversifyingthe markets,may have also
contributedto the lack of growth in the ECI/G program. Since non-L/C payment
methods are consideredmore risky, the low indemnificationunder PEFG may also
have caused potentialusers of ECIIG to not insure because of doubts regarding
PT. ASEI fully covering losses under insurancecoverage. Other problems of
the ECIIG program are the excessivecomplexityof policy forms (runningto
dozens of pages) and the lack of experienced,trained staff to underwrite. If
ECI/G activitiesare to expand and new policiesand proceduresdeveloped,PT.
ASEI will have to find ways to increaseskill levels of its staff through
training.

D. The Current Pattern of Incentives

2.50 The range of trade policy instrumentsoutlined in this chapter and

the complex price effectswhich these instrumentsproduce,make it difficult
to capture the overall incentiveeftects that the trade regime has in one
simple measure. This is particularlythe case where NTBs on imports or the
regulationson exports are implementedvia non-transparentmechanismsand the
height of the trade barrier varies significantlybetween productsand over
time. One approach to this problem that has been usefully employed in a
number of countries,is to analyze the pattern of both nominal and effective
(NIPs)measure the
rates of protection. Nominal rates of protectiLonJ
differencebetween the observed domesticpriceof a product and the prevailing
world price (adjustedfor quality differencesand transportcosts to a common
point of sale). NRPs provide a useful measure of the tax imposedon domestic
consumers (i.e., the differrAcebetween world and domesticprices) and a
partial picture of resourcepulls. One major drawbackwith NRPs, however, is
that they do not take account of the protectionon the inputs needed to make
the product. To address this problem it is common to use effective rites of
protection,which measure the protectionto net value added in an activity,
i.e., taking into account the taxes and subsidiesimposed on both inputs and
outputs. ERPs provide a more completeassessmentof the degree to which
resourcesare attracted towards a particularactivity. The ERP's presented
 - 56 -

here attempt to capture the aggregateeffect of trade and commercialpolicies

includingNTB's, import tariffs,export taxes and subsidies.14/

2.51 Estimatesof NRPs and ERPs for 1988 togetherwith the sectoral
coverage of NTBs in 1989 are presented in Table 2.8. They show that the net
effect of trade and commercialpolicies is a heavy tax on tr&Ie. The ovrall
anti-tradeor anti-exportbias of these policies is clearly shown by comparing
the aggregateERP for all import-competing goods (44Z) against that for all
exporting-competinggoods (-2X). This bias in favor of import-competing
activitiesalso applies for comparisonsbetween sectors and for broad
industrialgroups. Thus, manufacturingis highly protected relativeto mining
and quarrying,and agricultureis less highly protectedthan manufacturing. A
recent partial update of these NRP and ERP estimates shows that while there
has been a marginal decline itL the aggregatelevel of protection,the same
overall pattern of incentivesstill holds.15/

2.52 The bias against export-competing sectors is also a featureof each

broad industrialgrouping. In primary industries(agriculture,forestryand
mining), export-competingactivities- such as logging,rattan, rubber,coffee
and vegetable oils - have low ERPs and are subject to bans, quotas and taxes;
whereas import-competingsectors - such as milk, soybeansand sugar have high
ERPs and receive direct or indirectsubsidies. In the manufacturingsector,
the pattern is more complex but the same overall bias exists. High protection

14/ Two important caveats to the data should be noted. F4 st, many of the
price comparisonsthat were used in estimatinp r -d ERPs were
done in 1987/88. Where NTBs have been subseo fed the price
comparisonhas been replacedby the world or e relevant
nominal tariff. To the extent that domest- on has lowered
domesticprices below the prevailingnominal rate, the reported
ERPs overestimatethe level of protection. Se, the effects of
BAPEKSTA are not directly taken into account. To the extent that
BAPEKSTA lowers the cost of importedinputs, its effect will be to
raise the ERPs of many export-competing activities(e.g.,wood and
paper products,textiles, footwear,etc.). On the other hand, domestic
sales by export-competingfirms may also have exerted downwardpressure
on the domesticprice of some finishedproducts,which would lower the
estimatedERPs. Both of these caveats can only be satisfactorilydealt
with by establishingan institutionalcapacitywithin Indonesiawhich
undertakesprice comparisonson a regularbasis. The sketchy
informationon current price comparisonsthat we have obtained
indicates that the broad pattern of incentivesdiscussedhere is
generally accurate.

15/ "UpdatedEstimates of Nominal a EffectiveRates of Protection",by

P. Wymenga, Ministry of Industry,TechnicalNote 15. This study has
updated the Bank's earlierwork by revisingthe productionand export
weights, and by using a more up-to-dateversion of the nominal tariff
structure. A full update is planned, once an ongoing exercise to
collect current price comparisonis completed.
 - 57 -

Table2.8s TEE PATTRN OF INCENTIVES

IT 1988

Nominal Effective
NTB Rate of Rate of
Coverage/a Protection/b Protectionlb

Agriculture 40.9 12.6 20.7

Food crops 65.9 13.9 24.6
Estatecrops 28.2 3.9 11.3
Livestock 8.0 22.9 35.2
Forestry 0.0 -4.9 -6.8
Huntingand fishing 14.9 22.3 27.6
Miningand Oil 0.2 0.1 -0.8
Miningand quarrying 0.0 2.4 0.7
Oil refiningand LNG 0.4 0.0 -0.9
Manufacturing 44.5 19.8 73.3
Food,beveragesand tobacco 67.4 21.3 149.5
Textiles,clothingand footwear 25.2 25.0 79.1
Wood products 0.0 -1.4 -2.9
Paperproducts 47.6 13.3 16.8
Chemicalproducts 14.6 13.0 39.6
Non-metallicmanufacturedgoods 16.7 17.5 63.3
Basicmetals 23.5 5.6 8.3
Engineeringproducts 53.3 39.6 148.0
Othermanufacturedproducts 24.9 28.9 86.1
TotalEconomy(Ex-Oil& Gas) 28.9 16.2 31.1
Memo Item
Average for importables - 20.7 43.7
Average for exportables - -1.0 -1.9

La NTB coverageestimatedas percentof domesticvalueadded (at unassisted

prices)protectedfromimportcompetition via the RestrictedGoodsList.
/b Backgroundpaper,"An Updateof the EffectiveRate of ProtectionStudy"
by G. Fane.

is affordedimport-substitutionactivities - suchas mechanicaland electrical

machinery,motorvehicles/cycles, tyresand processedfoodand
beverages- whereaslow protection is affordedexport-competing
industries- suchas somewood products,paperand a rangeof other
manufacturedgoods. However,thereare important exceptionsto thisoverall
trendas illustratedby the low ERP for basicironand steeland the high ERP
for textilesand footwear.
 _ S8 -

2.53 The complexityof the pattern of incentiveswithin manufacturing

reflectsGOI's efforts to stimulatenon-oil exports at the same time as
continuingto protect existing import substitutionactivities. This dichotomy
is clearly illustratedin the textilesand footwear industrieswhich have
recently switchedto primarily export-competing activitiesand yet receive
high levels of protectionon the domesticmarket. This reflectsthe dual
structureof incentiveswhere exportersare protected from the 'high-cost'
local economy by export assistancemeasures (primarythrough BAPEKSTAand
BKPM), while producers for the domesticmarket continue to receivehigh tariff
and/or NTB protection. Also some export industriesreceive input subsidies
(primarilyin the form of export bans, quotas and taxes on upstream inputs)
which raises their ERPs - particularlyon domesticsales (e.g., rattan or
wooden furniture).

2.54 The strong connectionbetweea the share of domesticproduction

protectedby NTBs and relativeERPs is also shown in Table 2.8. In
manufacturing,four of the five most highly protected activitiesin terms of
NTB coveragealso rank highest in terms of ERPs (i.e., food and beverages,
engineeringproducts, textilesand other manufacturedgoods). In agriculture,
the link is less strong. This primarily reflectsthe importanceof rice in
the agriculturalsector, and the fact that althoughrice is under an NTB this
has not resultedin domesticprices varyingwidely from internationalprices.
The large weight of rice in agriculturalvalue added is reflectedin the high
aggregateNTB coverage ratio for food crops, while the parity with world
prices reduces the aggregateERP estimate. More disaggregatedestimatesshow
that this is not the case for other food crops. For example,soybean and
sugar have the highest ERP's within the food crop sector (about 10OZ), and
both are under NTB protection. Also for those goods which have a high import
tariff rate, the ERP is likely to be high even where the NTB coverageis low.
This is most clearly illustratedfor non metallic and other manufactured
goods, both of which have low NTB coverage ratios but relativelyhigh ERrs due
to high import tariffs.

2.55 Finally, one other characteristicof the current pattern of

incentivesthat is not captured in Table 2.8, is the wide variance of
protectionwithin both the msnufacturingand agriculturalsector. This is
also a feature at a more disaggregatedlevel for particularindustries. Thus,
even though the average ERP for basic iron and steel products is relatively
low, this industryhas one of the highest rate of dispersion.16/ In this case
the high dispersionreflectsthe effect of NTBs on selectedproducts (which
have a relativelysmall productionweight) and the use of
surchargeslsplit-tariff positions. Thus, vhile there is a general move
towards deregulation,in some instancesthis has been accompaniedby more
precise targetingof assistanceto specificdomesticproducerswithin an
activity. This wide range of protectionwill slow the process of
restructuringwithin an industryas resourceswill not be encouragedto move
out of less efficient activities.

16/ The index of dispersionfor the iron and steel industryis 120,
comparedwith an average of 42 for the whole manufacturingsector.
 - 59 -

CUAPTE 3

EFFECTS OF THE TRADE RBIDAS ON SElECTED MANUFACTURE

ACTIVITIES

A. Introduction

3.01 In the proceeding chapter the trade regime is discussed in terms of

how individual policy instruments effect a range of economic activities. This
chapter takes an industry approach, analyzing how particular industries are
effected by the range of trade policy instruments. Four industries are
analyzed: Steel, Paper, Textiles and Footwear. These industries have been
selected to represent the spectrum of manufacturing activities in terms of
their trade orientation.11 A stylized picture of the different trade
orientation of these industries, determined primarily by the most important
source of demand growth since the early-1980s and an analysis of the
prevailing trade regime, is shown below. This classification should not be
interpreted too literally as it is only intended to capture the broad trade
orientation of each industry. For example, some parts of the steel industry
have become export oriented, just as some parts of the footwear industry are
geared towards satisfying domestic demand. Other industries are in a period
of transition, where the primary source of demand growth has switched, or is
in the process of switching, from the domestic to the export market - i.e.,
paper, and, in particular, textiles. Thus, the trade orientation of an
industry will alter in response to changes in the incentive regime and
developments in the domestic economy.

Trade orientation Industry

Inward-oriented Steel
Paper
$ Textiles
Outward-oriented Footwear

3.02 All of the selected industries have maintained positive growth rates
since the early 1980s, ranging from a high 43.12 p.a. for the paper industry
to 11.12 for the footwear industry (1983-88). All of the industries have
grown more rapidly in the second adjustment period (1986-88) than in the first
adjustment period (1983-86), with the increase in the rate of growth in value
added being highest in the more outward-oriented industries: paper, textiles,
and footwear. As these industries are more labor intensive than the
inward-oriented industries there has been a corresponding acceleration in the
rate of growth in employment. There is also some evidence of a move towards

1/ It is important to stress that these industries have not been selected

because they are any betterl or Tworsew than any other industries in
the manufacturing sector. The intention is purely to capture a
representative of inward and outward oriented activities.
 - 60 -

more laborintensive productswithinindustries - particularly

in textiles.
Host of the increasein growthsince1985,has derivedfromthe rapidgrowth
in exports. While textileexportsremainby far the most importantin terms
of value,each of the otherindustries attainedhigherexportgrowthratesin
the secondadjustment period,albeitfroma relatively smallbase.21 Even
thoseindustries that are classified as being inward-oriented
(e.g.,steel,
and to a lesserextentpaper),demor3trated that thereare certainproducts
withintheseindustries which can competeon the internationalmarket.
Finally,in threeout of fourof the industries whichexperienced positive
growth (i.e., textiles,paper and steel) iLports also increased.

3.03 The major trade policy issues that arise from these industry studies
differ accordingto the trade orientationof the industry. For those
industries,or parts of an industry,that are primarilygeared towards
import-substitution, the most importanttrade policy issues ares the remaining
incidenceof NTBe, high tariff protectionon 'upstream'inputs, and the
increaseduse of split-tariffpositions and surcharges. While the sequential
approachto trade reform has suited the Indonesiancontext, it has allowed
some manufacturingactivitiesto maintain their highly protected status. Some
non-competitiveactivitiesremain under NTBs (e.g., cold rolled steel
products) or have been partially deregulated(e.g.,moved to the less
restrictiveIP license)but accordedhigh import tariffs. In these cases
tariff positionshave often been split to target the remainingNTBs or
surchargesto particularproducts or producers. This has resulted in a
fragmentationof the trade regime and a loss in transparency. It has also
significantlyincreasedthe dispersionof protectionwithin an industryand
reduced competitivepressures to restructure. Downstreamusers of these
commoditiesthat produce for the domesticmarket, such as galvanizedsteel
sheet producersor tin can users, are particularlydisadvantagedas they
cannot use the BAPEKSTA facilityto obtain importedinputs.

3.04 Broadeningthe reform program to encompassthose activitiesthat rely

primarily on supplyinga highly protecteddomesticmarket will be difficult-
particularlywhere there is considerableexistingcapital stock.
Nevertheless,the hidden costs of not tacklingthese anomaliesare high in
terms of both slowing the further efficientdevelopmentof the manufacturing
sector and reducingthe tax on Indonesianconsumers. In addition, there are
strong indicationsthat import-substitution industriesdo have the capacityto
restructurewhen faced with increasedcompetition. The recent expansion in
steel exports and reports from downstreamsteel users of a more 'businesslike'
attitude from large domestic steel supplierssupport this hypothesis. Where
restructuringis not possible,alternativesteps will need to be taken to deal
with the financialimplicationsof further trade reform.

3.05 For those industriesthat are outward-orientedthe most important

trade policy issues are: high tariffs (and a few NTBs) on their imported
inputs and the dependenceon BAPEKSTAthat this creates,the increasinguse of

2/ Between 1986-88 footwearexports increased246Z p.a., paper 104? p.a.,

and steel 82? p.a.
 - 61 -

export bans and taxes on upstreamunprocesseddomesticinputs, and continued

high import tariffs on their outputs. Some of Indonesia'sfastest growing
export industriesreceive levels of protectionon their domestic sales well
above the manufacturingsector average. This reflectsthe continued
prevalenceof relativelyhigh import tariffs (and in some cases NTBs) on
importedinputs and, as a consequences,even higher tariffs on outputs. In
some instances,these high levels of effectiveprotectionalso reflect export
bans and taxes on upstream domesticinputs (e.g., leather for footwearor
rattan for furniture). Medium to large-scaleexportershave been able to
circumventtariffs and NTBs on importedinputs by using the BAPEKSTA facility.
Firm level interviewsconfirm BAPEKSTAsadministrativeefficiencyand how
importantthe scheme is for reducingimport costs and increasingthe pressure
on domesticsuppliersto become more competitive. Nevertheless,BAPEKSTAhas
been less successfulin assistingsmall-sce.rand indirectexporters,and it
cannot assist producersfor the domesticmarket. In addition,high tariffs on
the output of some export industries(e.g., textilesand footwear)has reduced
the competitivepressure on high cost producers for the local market.3/ This
has penalized the Indonesianconsumerwho cannot buy goods at the export
price.

3.06 If non-oil exports are to double in the next five years, as projected
in RepelitaV, the trade reform program needs to take a more direct approach
to reducing import trade barriers. The removalof all remainingNTBs on
importedinputs into export activitiesand a general loweringof tariffs would
reduce the pressurecurrentlybeing put on BAPEKSTA. Such g move would also
assist small-scaleand indirectexportersand begin to share the benefits of
Indonesia'sincreasedcompetitiveness with domesticconsumers. Finally, the
use of export barriersto lower the cost of domesticinputs needs to be
reviewed. If downstreamusers of domesticraw materials (e.g., furniture
makers) cannot compete on world markets with inputs purchased at world prices,
there is a questionconcerningwhether this is an efficientuse of Indonesia's
resources. Even if one takes the view that these downstreamusers will become
competitiveovertime,this would support a low export tax and not, as is
currentlyhappening,the impositionof bans and extremelyhigh export taxes.4/
In addition,full account needs to be taken of the income loss for primary
goods producersand the damagingmedium-termeffects on efficiencyenhancing
investmentsin the taxed activity (e.g., raw leatherproduction).

3/ Exportersmust pay the import duty on that part of their imported

material inputs that are sold on the domesticmarket.

4/ For example,an export tax of US$250 to US$2,400per m/ton was imposed

on sawn timber exports in October 1989. This has resultedin many sawn
timber mills facing severe financialdifficultiesbecause of their
inabilityto export profitabilityat these tax rates.
 - 62 -

B. TEXTILES

3.07 The textiles industryis Indonesia'smost importantexport-oriented

manufacturingactivity. According to the 1986 EconomicCensus, textiles
accountsfor 12.3Z of non-oil manufacturingvalue added, and almost a fifth of
Indonesia'sfactory labor force. Along with footwear,the textilesindustry
is often consideredthe "litmus-test"of the country's export promotion
strategy- success in textiles is seen as an importantstep in attracting
other 'footloose'manufacturingactivities.

3.08 Textilesactuallycomprises of three distinct sub-industries;

spinning/fibres, weaving/fabrics;and garments. These sub-industriesdiffer
in a number of respectsincludingtheir capital intensity (high in
spinning/fibres,through to low in garments),export orientation (low in
spinning/fibres,through to high in garments),and ownership (significant
foreign ownership in spinning/fibresto high domestic ownershipin garments).
Internationally,the industryis distinctivefor the high regulationin
importingnations, principallyNorth America and the EuropeanCommunity. This
regulationoccurs under the auspices of the Multi-FiberArrangement (MFA),
which has been describedas, "the most trade-restraining international
agreementfor manufacturedproducts in existence."5/

Recent Performance

3.09 Indonesia'stextile industryhas performedstrongly,with value added

increasingby an average 162 p.a., and employmentby 91 p.a. over the period
1975 to 1988. Growth was particularlyrapid after 1985. The growth in value
added increasedfrom an average 15.72 p.a. in the import substitutionphase of
1980-85to 24.211 in the more outward-oriented phase of 1985-88,with the
growth in employmentincreasingfrom 5.3Z p.a. to a strong 15.71 p.a.
Although the expansion in employmenthas always been lower than output, due to
the adoptionof more capital intensivetechnologiesand the shift to higher
value products, there has been a shift towardsmore labor intensiveactivities
in the period since 1985. This reflectsthe rapid growth of the garments
sub-industrywhich employsmore labor per unit of output than the industry
average and a shift to more labor intensiveproductswithin each sub-industry
(see Table 3.1).

3.10 All three sub-industrieshave grown rapidly since 1975, at annual

rates of 222, 121 and 39Z for spinning,weaving and garments respectively. In
spinningand garments,the high growth rates shown in the first sub-period
(1975-80)in Table 3.1, reflectthe initial small base and the "easy' import

5/ William R. Cline, "The Future of World Trade in Textiles and Apparel",

Institute for InternationalEconomics,Washington,1987.
 - 63 -

Table E.1: OTPUTUNDEIWtYDENTDi THETEXTIUESECTW

1976-es

Splnnlng/Flbre Wetvina/Fabric Garments Total

--------------------------------- Growthp.a. ----- --------------

Value Employment Value Employment Value Employment Value Employmnt
Added Added Added Added

1976-00 29.6 16.9 4.8 2.1 52.9 89.6 12.4 6.6

1980-SF 14.7 4.6 18.8 1.6 28.9 17.9 16.7 6.8
1986-Ua 28.9 14.2 21.6 12.7 82.1 22.2 24.2 16.7
1975-85 22.4 11.8 11.8 4.2 88.6 26.6 16.8 9.2

------- ---- -- Shar __---______aes…

1976 16.9 9.1 82.0 86.7 2.1 4.2 100 100
1980 14.9 14.4 72.2 69.7 9.6 16.9 100 100
'985 81.2 18.9 62.1 68.1 16.7 28.0 100 100
1988 81.0 18.4 49.0 58.7 20.0 88.0 100 100

Source: BPS and statf satimates.

substitutionperiod of development.6/ In the second more inward-oriented

sub-period(1980-85)the faster growth in weaving more than offset slower
growth in both spinning and garments. However, as the growth in weaving was
accompanied by a shift in the commercial sector from hand-looms to
power-looms,the rate of growth in employment declined during the
import-substitution phase. In the third more outward-orientedsub-period
(1985-88)the rate of growth of output and employmentin all three
sub-industriesaccelerated,primarilydue to the expansion in exports. Growth
was particularlystrong in garments.

3.11 The major transformationin the industryhas been the recent boom in
exports (see Table 3.2). Exports first began to increasein the late 1970s,
followingthe November 1978 devaluation. But the benefits of devaluationwere
quickly eroded by the appreciationof the real exchangerate resultingfrom
the second oil price increase. More sustainedgrowth occurredafter 1982, in
response to the April 1983 devaluation and implementation of the Government's

6/ The lower growth of weaving in 1975-80 reflectedthe completionof much

of the import-substitutionpossibilitiesprior to 1975. The slow
 - 64 -

Table 3.2: EXPORT PERFORMANCEOF TEXTILES SECTOR 1975-88

Current Prices (USS Million) Real Growth Rate

1975 1980 1985 1988 1975-80 1980-85 1985-89

Spinning/Fibre neg. 3.1 12.6 119.6 - 28.4 107.9

Weaving/Fabric 2.0 42.7 227.1 571.1 73.8 35.9 33.4
Garments 2.4 98.3 339.2 796.7 98.0 24.6 30.4

Total 4.4 144.1 578.9 1,487.4 89.4 28.5 34.3

Source: BPS and staff estimates.

SertifikatEkspor (ExportCertificate)scheme. The growth of exports

acceleratedagain (from a much larger base) after 1986 followinga further
devaluationin September,and the implementationof trade reform measures
designed to increaseproducersaccess to importedinputs at world prices.
Export growth rates in excess of 30Z p.a. have been attained in all
sub-industriessince 1985, althoughthe spinningexport base was very small.
The relativeexport magnitudesreflect the factor endowmentsin the three
sectors,with garment exports some 50X greater than those of fabric and about
9002 greater than fibre exports. F

3.12 The Import data (Table 3.3) reflects the interplayof economy-wide
and policy factors. During the initial period (1975-80),importsof fibre and
fabric increasedmoderately,but garmentsdeclined primarilyas a result of
the growth of the domestic industrybehind high import tariffs. In the second L
period (1980-85),lower overall economicgrowth, coupledwith the imposition

Table 3.3: IMPORT PERFOUMANCEOF TEXTILESSECTOR 1975-88

Current Prices (fS$ Million) Real Growth Rate (Z D.a.)

1975 1980 1985 1988 1975-80 1980-85 1985-89

Spinning/Fibre 120.5 186.1 102.5 201.4 3.0 -13.7 22.8 ^w

Weaving/Fabric 66.1 126.2 74.7 168.8 7.5 -12.4 28.7
Garments 4.8 3.1 3.8 6.5 -45.5 1.1 17.5

Total 191.4 315.4 181.0 376.7 4.4 -12.9 25.2

Sourcet BPS and staff estimates.

 - 65 -

of NTBs led to an average 13Z p.a. decline in total textile imports. The
decline was particularlymarked in the upstream fibre and fabric
sub-industrieswhere most of the NTBs were focussedand large domesticweaving
capacitycame on-stream. In the period since 1985, imports in all three
sub-industrieshave grown strongly. This reflectsthe strong growth in
garment exports and the change in trade policy - particularlythe introduction
of the duty exemption and drawbackscheme (BAPEKSTA).

3.13 That export growth has had a dramaticeffect on the textilessector

is evident from the decompositionof sources of demand growth provided in
Table 3.4. Indeed the data understatethe importanceof exports,as much of
the growth in domesticdemand since 1985 has reflectedthe expansion in fibre
and fabric capacitydesigned to supply inputs to garment exporters. Table 3.4
also shows the period of import-substitution(1980-85)when many of the more
capital intensiveupstream fabric and fibre plants were commissioned. Since
1985, import-substitution has been a "negative"source of growth, implying
that the total growth in export and domesticdemand outstrippeddomestic
capacity. The simultaneousgrowth in domesticoutput and importshas been
facilitatedby the deregulationof import controlsand the expanded use of
BAPEKSTA. Garment exportershave increasinglyused importedcloth both as a
means of establishingproduct reputationin internationalmarkets and in
responseto the specificrequirementsof global brand-namegarment outlets
which begun sourcingfrom Indonesiaduring this period.7/

Table 3.4: SOURCES OF GROWTHIN TEXTILES SECTOR:

PRODUCTION,TRhDE MNDCONSUMPTION

Export Import Domestic Exports as 2 of Total

Substitution Demand DomesticProduction /a

1975-80 17.1 -7.5 90.4 0.6

1980-85 70.4 30.8 -1.2 7.9
1985-88 62.2 -13.2 51.0 21.6
1975-88 49.2 -2.2 53.0 35.0

/a Period average.

Source: BPS and staff estimates.

7/ Some garment exportersexpressedthe view that they use foreign imports

for a portion of their fabric to forestallany pressure from domestic
fabric producersto dilute BAPEKSTAscurrent liberalprovisions. These
exportersfear that fabric producersmay invoke the 'domesticcontent"
arrangementto persuade the Governmentto tighten trade restrictionson
the grounds of demonstratedlocal competitiveness. This would, they
argue, greatly reduce the pressureon domesticfabric producers to
remain price/qualitycompetitive.
 - 66 -

3.14 Indonesia'smajor export market is the OECD bloc and, to a lesser,

extent other Asian NICs. For garments,the United States is the dominant
market, absorbingover 40Z of the five largest garment items. The second
market is the UK or West Germany dependingon the product. Indonesianexports
to the EC have been considerablysmaller than those to the US, partly because
import demand is less, but also because markets and distributionchannelsare
more complex and fragmented. A notable feature of Indonesiangarment exports
is the unimportanceof Japan as a market. Japan is not a signatory to the
MFA, so Indonesiamust compete against all countries in this rnarket. The
principal reasons for the low export volumes are, Japan has only recently
become a major garment importerand, the Asian NICe have been better placed to
take advantageof the much more quality consciousJapanesemarket, with its
intricatemarketingnetworks. Several Indonesianfirms have active plans to
penetratethe Japanesemarket, drawing on their commercialcontactswith major
Japanese tradinghouses. This could be major source of future growth, but it
will require continuedaccess to high quality fibre and fabric.

3.15 Export markets for fabric anc fibre are diverse, and export quotas
are not such a handicap. In the case of fabricsSingapore is a malor market,
reflectingits continuingrole as the entrepotcentre for SoutheastAsia,
togetherwith its tourist demand. Industrysources suggestother markets are
often determinedby periodic supply shortagesnecessitatingfabric imports
e.g., Malaysia and UAE.

Effects of the Trade Regime

3.16 The trade regi4e directlyeffects the textilesindustry in three

principalways: ti) the quota allocationmechanism; (ii) import tariffs/NTBs
on importedinputs and outputs;and (iii) the BAPEKSTAfacility.

3.17 Until the mid 1980s the need for an efficientquota allocation
mechanismwas not pressing - the countrywas under quota ceilings in most
items and the MFA had 'perverseprotective'effects for newcomer exporters
(such as Indonesia)through the restraintsimposed on other established
exporters (principallyto Asian NICs). However,as shown in Table 3.5, export
quotas have begun to 'bite'. Future sales to the US and EC will, therefore,
be constrainedto agreed quota increasesand a shift to higher value items.
This makes it essential that quota allocationsare distributedas efficiently
and equitablyas possible.

3.18 The current system for allocatingtextilesquotas has been subject to

much debate in Indonesia. But before discussingits shortcomingsit should be
noted that the high and rising quota ratios shown in Table 3.5, demonstrate
that most of the quotas are eventuallyallocatedto firms. Nevertheless,even
a minor underutilization of quota (of say 5Z) can result in a substantialloss
in export revenue (about US$50 million).
 - 67 -

Table 3.5: TEXTILE QUOTA UTILIZATIONRATIOS

1984 1985 1986 Ratios

USA
Group 1 items 77 93 96 99
Group 2 items n.a. 95 106 122

EC 76 68 74 85

Source: Departmentof Trade.

3.19 The major shortcomingsof the current allocationsystem includes

(a) Administrationis non-transparent. The Departmentof Trade allocates802
of its allottedquotas accordingto past performance,102 to newcomers and 102
to cooperatives. The criteriafor decidingwhich firms receive initialquota
allocationsare not clear, and the Departmentrarely publishes a comprehensive
list of current quota holders. Some firms with satisfactorypast performance
have had their quota allocationscut without explanation,and the definition
of 'newcomer'exporters is particularlyunclear. The annual growth in quotas
(between32 and 62) has been predominantlyallocated to the ill-defined
'newcomer'category, and there have been complaintsthat the additional
allocationshave been made too late in the quota year. It has also been
observed that some quota holders possess little, if any, productivecapacity,
and operate simply be resellingquotas; (b) The quota exchangemechanism
deters open trading. Although the Governmentdid establisha Textile Quota
Exchange, the penalties for using it constitutean incentivefor transferring
the quotas outside the Exchange. Currently the quota holder losses 202 of the
quota sold on the exchange. As a consequence,quota holders only trade low
volumes on the Exchangeto gather price signals. Quota holders that neither
use or transfertheir quota rights are penalized at a rate of 2002 of the
unused quota. These unused quotas are retumnedto the Governmentto be
reallocatedby the Ministry of Trade; and (c) Administrationis slow. Quotas
are generallynot allocateduntil after the quota year has commenced;in some
cases, accordingto firm interviews,this can be up to three months into the
quota year. This adverselyeffects exporters,who can miss lucrative
contractsearly in the year. In addition,the MPA has several flexibility
clauses that enable the exportingcountry to 'switch'quotas from one product
to another (or one country to anotherwithin the EC) and to 'carry-over'
quotas from one period to another. These flexibilityclauses demand accurate
monitoringand forecastingcapacities,which apparentlyare not well developed
in Indonesia.

3.20 The present quota allocationand tradingmechanismhas several

weaknesses. The non-transparentnature of the system encouragesfirms to
allocate resourcesto wasteful rent-seekingbehaviorto preserve or increase
 - 68 -

their export interests. In ddition,the degree of administrationdiscretion

increasesuncertaintyfor investorsand creates opportunitiesfor abuse.8/
Both these factors are enhancedby the incentiveto trade quotas informally
outside the Exchange. Furthermore,the allocationof quotas based on past
performancecan act as a barrier to entry, and thereby impede dynamic
efficiencygains over the medium term. Finally,the current system makes it
difficult to identifywho receivesthe quota rent, and therefore,difficult to
decide whether the distributionis equitableor in the textile industriesbest
interests.

3.21 With respect to import tariffs and NTBs, GOI have removed all
restrictionson one of the major inputs into the textile industry- cotton.
In 1986, cotton importswere moved from the approved import category to the
more open IP license category,which enabled domesticusers to import cotton
directly. In the January 1987 package,cotton importswere deregulated
further by being moved off the restrictedgoods list and reclassifiedas an IU
item. Cotton importswere still not completelyderegulated,however, as
importershad to purchase 1 ton of domesticcotton for every 10 tons of
importedcotton. This restrictionwas lifted in November 1987. Interviews
with firms have confirmedhow importanthaving non-restrictedaccess to cotton
has been in allowing them to be competitivein terms of both price and
quality.

3.22 The only major importedinputs that remain on the RestrictedGoods

List are some types of syntheticfibres,which are listed under the least
restrictiveIP license.91 The need to protect domesticsynthetic fibre
producersmay itself be due to an "informalOtrade restrictionon one of the
most importantinputs into syntheticfibre - PTA. The domestic synthetic
producershave informallyagreed to source about half their PTA needs from the
Pertaminaplant which was opened in 1986. In return Pertaminahave agreed to
sell at import-paritylevels. However,some producers claim that poor
deliveryand quality raises their actual costs, and that the price is often
high due to unnecessarymiddle-menbetween themselvesand Pertamina. Domestic
syntheticfibre producers are also concernedthat Pertamina'splan to expand
the domestic PTA plant to supply all domestic requirementswill be followedby
lobbyingto increasetrade barriers. If this occurs, fibre productswill also
be forced to seek more protectionto stop fabric manufacturersimportingall
their needs through BAPEKSTA.

3.23 While most of the 'upstream'inputs into fibre productionreceive low

import protection,this is not the case for finishedproducts. The current

8t The value of quotas should not be underestinated. For example, in

July/Augustquotas for profitableitems such as jeans were being sold
,informally"for up to US$12 per dozen. Thus, a quota of say 50,000
dozen would be worth US$600,000.

9/ This allows downstreamusers of syntheticfibre to import it if they

can establishthat the domesticproduct is not competitivein terms of
price or quality.
 - 69 -

tariff scheduleprovides escalatingtariff protectionfor the textiles

industry,increasingfrom an average 33Z for fibres aad fabrics to a high 58?
for garments.10/ In addition,all batik textile items are on the Restricted
Goods List, and can only be importedby the State Trading Companies (STCs).
In effect, this has resultedin an informalban on batik textiles. Both the
escalatingtariff and the restrictionson batik are designed to protect high
cost local producers that sell primarilyon the domesticmarket. Textile
exporters are able to circumventthe cost of raising effects of this import
policy by using the BAPERSTA facility. Given the dominanceof competitive
textile producers that sell at world prices, the case for continuingto offer
high protectionon final productsseems weak. Unless producers for the
domesticmarket are forced to compete the industrywill become dualistic,with
one highly efficientpart geared to supply foreign consumers,and another high
cost part geared to supply domesticconsumers.11/

3.24 The BAPEKSTA facilityhas played a key role in the growth in the
textile industry since 1986. It has not only allowed textile producers to
access imports at world prices, but, just as important,it has also allowed
them to by-pass any remaining import licenseprotection. In 1988,
approximatelya third of Indonesia'stextile exports utilize inputs imported
through BAPEKSTA,up from a tenth in 1986. This figure may understatethe
real impact of the facilityas some producers indicatethat they use BAPEKSTAs
approval to negotiatewith local suppliersto obtain more competitiveprices.
Firm level interviewsconfirm the importanceof BAPEKSTA,with many producers
consideringit to be of more importance(in terms of competitiveness)than the
September 1986 devaluation. There was also widespreadpraise for the
efficientadministrationof the scheme.

3.25 There are two sets of issues concerningBAPEKSTAs future role. The
first relates to improvingthe coverageof the scheme to include small scale
textile producers and indirectexporters. Interviewswith firms employing
less than 20 people indicatethat they often find BAPEKSTAsapplication
proceduresbeyond their limited administrativecapacity. Also, as documented
in Chapter 2, BAPEKSTA does not have an easy mechanism for assisting indirect
exporters. Both these constraintsneed to be addressedby simplifying
applicationproceduresfurther and using domessicletters of credit as a
vehicle to assist indirectexporters. Even if these improve~entsare made, it
is unlikely that BAPEKSTAwill ever reach all potentialexporters. In
addition,and this raises the second set of issues, BAPEKSTAcannot assist
producers for the domesticmarket or help reduce the tax on domestic

10, Average tariff plus surchargerate under the 1989 HarmonizedSystem -

weighted by domesticproduction.

11/ It should be noted that exportersare requiredto pay import duty on

the portion of their output sold on the domesticmarket. Nevertheless,
producers for the domesticmarket are already under some competitive
pressure due to 'leakages'from export-orientedfirms. As a
consequencecurrent import tariffs are probablyhigher than domestic
prices require (i.e., there is water in the tariff).
 - 70 -

consumers. While the efficientoperationof BAPEKSTAis crucial to the

textile industry given the current trade regime, it should not be seen as a
substitutefor more fundamentalreforms - particularlythe loweringof Import
tariffs.

C. STEEL

3.26 In the early 1980s, the steel industrywas at the centre of the
Government'sImport-substitution strategyfor 'upstream'manufacturedgoods.
High protection,mainly in the form of NTBs, coupledwith direct public
investment,encouragedthe developmentof an inward-orientedsteel industry
dominatedby the state-ownedXrakatau Steel plant. Since the mid-1980s,
however, there has been a significantimprovementin the industry's
competitivenessin many steel products. This has resultedin increased
exports,particularlysince 1986, and the selectiverelaxationof import
controls. Nevertheless,some importantsteel productsremain highly
protected,which has raised costs for downstreamusers. Steel providesa
useful case study of the type of problemslikely to occur in moving
establishedindustriesfrom an inward-orientedto an export-orientedor more
neutral trade regime.

Recent Performance

3.27 The steel industryhas shown strong growth over the entire period
1982-1988, expandingby an average 22Y p.a. (see Table 3.6). The fastest
growing part of the steel industryhas been in basic upstream steel products,
such as billets, slabs and basic hot rolled products,which grew at 332 p.a.
over the period. Most of the growth up to 1986, was geared towards supplying
the domesticmarket. Between 1983 and 1985, the nominal value of steel
imports fell by 36Z, reflectingboth the rapid growth in domesticoutput and
the increasedimpositionof NTBs. As a result, since 1983, the ratio of
imports to domestic output has declined from 1092 and 128? for basic steel and
metal products respectively,to 49? and 472 by 1986 (see Table 3.7).

a ble 3.6: OUTPUT GROWN IN THE STEEL INDUSTRY

1983 - 1986

Current Prices (RD. Billion) Real Growth Rates (i p.a.)

1983 1986 1988 1983-86 1986-88

Total steel sector 1L157 2,442 4,361 21.4 23.5

Basic steel 466 1,169 2,324 31.7 35.5
Metal products 691 1,273 2,037 13.5 9.6

Source: BPS.
 _ 71 -

Table 3S 7 RATIO OF DEPORTS AND EXPORTS X0 STEEL DOMESTIC PRODUCTION

1983 1984 1985 1986 1987 1988

Imports
Basic steel 109.3 68.3 38.6 48.5 47.7 47.4
Metal products 128.0 96.1 72.0 46.2 53.8 42.4

Exports
Basic steel 1.4 1.4 4.2 7.4 18.0 17.0
Metal products - - - - 2.7 5.1

Source: BPS and staff estimates.

3.28 Since 1986 there have been two major developments. First, the
publicly owned Cold Rolling Mill (CRMI)was comuissionedin 1987, reflecting
the latest phase in the import-substitution strategy. Second, efficiency
gains within the more establishedparts of the industry,combinedwith the
price effects of the devaluation,increasedIndonesia'scompetitivenessin
some product areas. Thus, in contrast to the earlier period, continued strong
output growth has been accompaniedby an expansion in the internationaltrade
of steel products (both exports and imports). This expansion reflectsgains
in competitivenessand the partial removal of import restrictions.

3.29 Exports of basic steel products increasedfrom about US$67 million in

1986 to US$245 million in 1988, with metal productsexports increasingfrom
US$2 million to US$62 million. While most of the expansionhas been in
establishedparts of the industry (e.g., hot rolled coil and wire rods), there
has also been growth in other steel products - primarilyproducedby the
private sector. One of the smallerprivate producers,who relies on imported
imports for half his material needs, reportedexporting 50? of his output in
1988, having increasedcapacityutilizationfrom 35? to 702 since
deregulation. In the larger volume hot rolled coil market, Japan accountsfor
about 80? of Indonesia'ssales and their purchaseshave risen 15-fold since
1986. Another source of increasingdemand has been China.

3.30 Imports have increasedby 30? in nominal terms since 1986, with
strongereconomicgrowth and deregulationmore than offsettingthe demand
reducingeffect of the devaluation. Some producers reporteda significant
fall in scrap and pig iron import prices followingthe removal of these items
these productswere removed from the RestrictedGoods List. This has -
increased the profitabilityof billet making for both the domesticand foreign
markets. Access to cheaper and more readily availableinputs were also
stressedby two manufacturersof reinforcingsteel productsas major benefits
of deregulation. They cited deliverydelays from KrakatauSteel and the
 - 72 -

subsequentpost-reformability to by-pass these, as the major reason

underlyingtheir ability to compete in export markets. Imports of steel sheet
and plate, the largest import category,have continued to grow, but at a
slower rate due partly to the commissioningof CRMI. As Krakatau steel cannot
produce sufficienthot-rolledproducts to meet CRMI's needs, there has been a
change in the compositionof imports towards hot-rolledproducts.

Effects of the Trade Regime

3.31 Steel has been one of the most heavily regulated industriesin the
manufacturingsector. It is also the only industrywhich has been includedin
all of the major trade deregulationpackages,which reflectsGOI's awareness
of the issues involved. The resultingpattern of trade policy related
incentivesis mixed. Saoneproductshave been completelyderegulatedand sell
at world prices, whereas others remain protectedby NTBe and/or high import
tariffs. luch of the continuedprotectionrelates to remnantsof the
import-substitution period - particularlycold rolled sheets and the
associateddownstreamproducts. While a furthe; restructuringof the industry
should be encouragedby continued trade policy !eform, other issues related to
how to compensateinvestorsin the existing stock will also need to be
addressed.

3.32 The dominant trade policy instrumentin the steel industryhas been
NTBs on imports,which have restrictedimports to Krakatau Steel (KS). With
the gradually relaxationof these restrictions,tariffs and surchargeshave
become more important. Recent developmentsin these two policy areas are
discussed first, followedby an investigationof the role oi BAPEKSTA.

3.33 In 1986 the incidenceof NTBs in the steel industrywas amongst the
highest in the manufacturingsector,covering862 and 912 of the domestic
productionof basic steel and metal products respectively. The progressive
removal of these restrictionsis charteredin Table 3.8. Of the products
deregulatedin the early trade reform packages (October86 and January 87),
one of the most importantwas waste and scrap iron and steel. This gave
domestic producers,other than KS, better access to a basic steel making raw
material. As noted earlier,this has led to a marked increasein scrap
importsby some of the private sector steel producers. While many of the
basic steel inputs requiredby downstreamusers remainedunder the restrictive
KS license (e.g., slab, billets, sheets),the Decemberpackage focussedon
removingNTBs on a range of goods producedby downstreamprivate producers.
These included steel rods and bars, most pipes, nails, screws and bolts. The
December 1988 package pushed the removalof NTBs on basic steel products
further. Some types of steel billets and slabs were removed from license
protection,while others were moved off the KS license to the less restrictive
IP license.12/

12/ If those items that are classifiedas IP were discounted,the domestic

productioncoverage estimatefor basic steel shown in Table 3.8 would

-~~~~~~~~
decline from 542 to 382.
 73 -

Table 3.8: COVERAGEOF IKPORT LICENSE RESTRICTIONS- SELECTEDBASIC

STEEL ANDSTEEL PRODUCTS,1986-1988
(Percentageof Domestic Production)

Pre Oct. Post Oct. Post Jan. Post Dec. Post Nov.
Industry 1986 1986 1986 1987 1988

Basic iron and steel 86 84 72 54 50

Structuralmetal
products 91 83 83 38 38
Agriculturaltools,
cutlery 29 12 12 12 12

Sou;ce: Staff estimates.

3.34 The overall pattern that emerges from the reforms to date is a
substantialrelaxationof NTBs on basic steel inputs (scrap,billet- and
slabs); less progresson the products in the next processingphase (coils and
sheets),and a significantremoval of NTBs on final downstreamproducts
(albeitwith&high tariff protection). The general approachhas been to move
most basic steel inputs to the less restrictiveIP license category, -o make
it possible for downstreamusers to access their inputs at world prices, and
to place higher tariffs (plus in some cases surcharges)on those products that
have been completelyremoved from the restrictedgoods list (i.e. IU
products). Those products that require the highest level of protectionremain
restrictedto KS, usually with a low nominal tariff (see Table 3.9). The
consequencesof the current pattern of inc6r.tives can be illustratedby
developmentsin the galvanizedsteel sheet industry. Faced with NTBs on cold
rolled steel sheets, this industrypurchasesdomesticsheets at about 202 to
30Z above import parity levels. As a result of the high cost inputs, the
industryitself suffers a price disadvantagein relationto imports of a
similarmagnitude and operatesat 40X of capacitybehind an import tariff of
30Z. Furthermore,because effectivesubstitutesin the form of asbestos -
cement sheets are available (one steel firm having diversifiedinto their
production)the price elasticityfor galvanizedsheets is high and further
contractionof the industryis likely.

3.35 With respect to tariff protection,the average level of statutory

tariffs in the steel industryis not high by either Indonesianor
internationalstandards. Neverthelessthis low averagemasks a wide
dispersionin tariff rates and a much higher average tariff for downstream
metal products. There has also been a trend towards slightlyhigher tariff
protectionfor basic steel products followingthe relaxet.onof NTB protection
(see Table 3.10). More importantly,the escalatingtariff pattern needs to be
assessed in conjunctionwith the use of NTBs discussedabove.
 - 73 -

Table 3.8t OF IMPORTLICENSE RESTRICTIONS- SELECTEDBASIC

COVERAGE
STEEL MD STEE PRODUCTS,1986-1988
(Percentageof Domestic Production)

Pre Oct. Post Oct. Post Jan. Post Dec. Post Nov.
Industry 1986 1986 1986 1987 1988

Basic iron and steel 86 84 72 54 50

Structuralmetal
products 91 83 83 38 38
Agriculturaltools,
cutlery 29 12 12 12 12

Source: Staff estimates.

3.34 The overall pattern that emerges from the reforms to date is a
substantialrelaxationof NTBs on basic steel inputs (scrap,billets and
slabs); less progresson the products in the next processingphase (coils and
sheets),and a significantremoval of NTBs on final downstreamproducts
(albeitwith high tariff protection). The general approachhas been to move
most basic steel inputs to the less restrictiveIP licensecategory, to make
it possible for downstreamusers to access their inputs at world prices, and
to place higher tariffs (plus in some cases surcharges)on those products that
have been completelyremoved from the restrictedgoods list (i.e. IU
products). Those products that require the highest level of protectionremain
restrictedto KS, usually with a low nominal tariff (see Table 3.9). The
consequencesof the current pattern of incentivescan be illustratedby
developmentsin the galvanizedsteel sheet industry. Faced with NTBs on cold
rolled steel sheets, this industrypurchases domesticsheets at about 202 to
302 above import parity levels. As a result of the high cost inputs, the
industry itself suffers a price disadvantagein relationto imports of a
similar magnitude and operatesat 402 of capacitybehind an import tariff of
30Z. Furthermore,because effectivesubstitutesin the form of asbestos -
cement sheets are available (one steel firm having diversifiedinto their
production)the price elasticityfor galvanizedsheets is high and further
contractionof the industryis likely.

3.35 With respect to tariff protection,the average level of statutory

tar4ffs in the steel industryis not high by either Indonesianor
internationalstandards. Neverthelessthis low averagemasks a wide
dispersionin tariff rates and a much higher average tariff for downstream
metal products. There has also been a trend towards slightlyhigher tariff
protectionfor basic steel products followingthe relaxationof NTB protection
(see Table 3.10). More importantly,the escalatingtariff pattern needs to be
assessed in conjunctionwith the use of NTBs discussedabove.
 - 75 -

3.36 One of the major concernswith the tariff structurein the steel
industry is the increasingprevalenceof split-tariffpositionsand
surcharges. This practice of subdividingthe existing9 digit level product
descriptioninto ever more finer product descriptionsenables protectionto be
targeted (eitherin the form of an NTB or tariff protection)to specific
products (i.e., those produceddomestically). The proliferationof
split-tariffpositionhas been associatedwith an increasedrelianceon
surcharges. As a consequence,the steel industryhas the highest incidenceof
surcharges (in terms of number of products) in the manufacturingsector.

3.37 Use of the BAPEKSTA facilityfor steel productshas increased

recently, followingthe expansionof exports. While exports account for only
a small proportionof the steel industriesoutput, BAPEKSTAserves two useful
functions. First, as the nominal tariff on basic steel products is low the
schemes primary benefit for users of these prodkictsis in allowingexporters
to circumventthe remainingimport license restrictions. Although the listed
price of these steel items is often at import parity levels,users complainof
uncertaindelivery and poor quality. In addition,one exporterof concrete
steel commentedthat the pessibilityof using BAPEKSTA,has encourageda more
competitiveand business line attitudefrom Krakatau Steel. The second
functionof BAPEKSTA is to provide users of downstreamproductswith import
duty exemptions. Given the cascadingnature of the import tariff structure,
the duty savings of about 20? to 302 are a significantpart of producers
costs.

3.38 In conclusion,the next phase of trade reform in the steel industry

will need to focus on reducingthe wide range of protectionprovidedto
differentproducers and products. The increasinglyfragmentedcharacterof
the current trade regime reflectsefforts to lower domesticprices on some
items to encouragethe developmentof downstreamindustries,at the same time
as continuingto protect less efficientdomesticproducers. The result has
been to slow the process of restructuringthe industryand raise input costs
for some downstreamusers e.g., galvanizedsteel sheets. The prioritiesfor
reform are the removal of remainingNTBs, followedby a move towards a more
uniform tariff structure (free of either split-tariffpositions and
surcharges). For cold rolled productsthis will require supportingmeasures
to directly address the financialproblems that CRMI will confront.

D. FOOTWEAR

3.39 The footwearindustryprovidesa useful case study in a number of

respectsincluding:

o it is representativeof the type of non-traditionalmanufactured

exports that have underpinnedIndonesia'sstrong non-oil export
performancesince 1986;

o it has been effectedby recent reforms in both the import and export
policy framework;
 - 76 -

o it has benefittedfrom a large inflow of foreign investment;and

o it has one of the highest levels of nominal and effective rates of

protection,at the same time as the industryhas clearly shown its
capacity to compete on world markets.

Recent Performance

3.40 The footwearindustryhas performedwell since 1983, growing at un

average 102 p.a. between 1983-86,and at least 12.02 between 1986-88.13/ As
the data in Table 3.11 shows, most of this growth has derived from the
extremely rapid expansion in exports. Startingfrom a small base, exports
have expandedat an estimated2462 p.a. over the past two years, increasing
their share of total domesticfootwearoutput from about 72 in 1986 to 61X in -
1990.14/ Most of this growth has occurredin sports shoes and in the cheaper -
form of plastic and rubber footwearitems. By contrast, imports stagnatedin
real terms during the period 1983-86,before declining significantlybetween H
1985-88. Footwear importsare now largely comprisedof high quality fashion
footwear and specialbrand-namesnot manufacturedlocally.

Table 3.11: FOOTWEAR: GROVTI IN OUTPUT, EXPORTS AND IMPORTS, 1983-88

Current Prices Real Growth Rates

(Rp. Million) (2 p.a.)
1983 1986 1988 1983-86 1986-88

Olutput 89,726 152,623 225,819 9.9 12.0

Exports 2,484 9,991 137,428 46.5 246.1
Imports 4,126 7,710 4,946 13.4 -25.3

Exports as
2 of output 2.8 6.5 60.9

Source: BPS and staff estimates.

13/ The publisheddata on output, exports and importswould indicatea

marked decline in domesticconsumptionbetween 1986 and 1988. Although
the domesticprice of footwearhas probablydeclined relativeto
internationalfootwearprices since devaluation,this shift in relative
prices is unlikely to fully account for the observed trend. As the
trade data are consideredto be robust, it is probablethat the growth
in domesticoutput is underestimated. This would not be unusual for an
industrywhich has recentlyexperiencedlarge inflowsof new
investment.

14/ To the extent that output has been underestimated(see footnote8),

this ratio is obviously too high.
 - 77 -

3.41 The rapid growth in exportshas been accompaniedby a large inflow of

foreign investment,particularlyfrom Taiwan and South Korea. In calendar
year 1988 a total of 32 new companiesreceivedBKPM approval for investmentin
the rubber shoe industryalone, 13 of which were foreign investors. There has
also been a significantre-orientationof export destinationsfor Indonesian
footwear,partly because many foreign investorshave brought ready access to
foreignmarkets with them. Most notable among these changes has been the rise
in tb-'US market in several product categories,and the growth of the EC
market (see Table 3.12). Penetrationof the Britishmarket has been
particularlysuccessfulin the cheaper forms of rubber and plastic footwear
and textile sports shoes. Finally, there has also been an increase in the
unit value of men's leather shoes, indicatinig
a move into the higher quality
end of the market.

Table 3.12: CHANGINGEXPORT MARKETS FOR LEADING INDONESIAN

FOOTVEAREXPORTS - 1986 TO 1988
PRINCIPALDESTINATIONSBY VALUE (US$S000)

-- 1986-------- --------1988-

Rubber/plastic Middle East 35 UK 4,269

Footwear France 14 UK 562
Malaysia 2 France 412

Mens/boys shoes UK 570 US 10,S76

Leatherwith rubber soles Eire 130 Singapore 1,014
Hongkong 62 UK 926

Leather sport shoes UK 231 US 1,701

Rubber soles West Germany 24 France 1,049
Netherlands 21 UK 1,018

Women's textile Netherlands 91 UK 1,844

Shoes, rubber soles West Germany 85 US 529
UK 31 Netherlands 93

Textile sport UK 2,935 UK 9,862

Shoes, rubber soles Netherlands 161 US 7,602
Belgia/Luxembourgh 91 France 3,918

Source: Central Bureau of Statistics- Exports,Various Years.

 - 78 -

Effects of the Trade ReRime

3.42 The rapid growth in Indonesia'sfootwearexports since 1986 is the

result of many factors besides changes in the trade regime. The decline in
Indonesianreal wages relativeto competitorcountriesand the removal of GSP
rights for Taiwan and South Korea are two important factors. In addition,the
relaxationof business regulationshas played an importantrole in
facilitatingthe inflow of foreignprivate investment. Nevertheless,as firm
level interviewsconfirmed,the series of trade reforms undertakensince 1985
have been central to the rapid developmentof the industry. Further reforms
of the trade regime will be needed to encourage and to maintain the momentum
towards increasedefficiencyand competitiveness.

3.43 The trade policy reforms that have effectedthe recent performanceof
the footwearindustryare: (i) the removal of NTBs on imports,particularly
leather; (ii) export bans and export taxes on domesticleather production;
(iii) the introductionof the BAPEKSTA facility;and (iv) continuedhigh
protectionfrom foreign competitionvia high import tariffs on final footwear
products.

3.44 The removal of NTBs on leather imports in the first trade

deregulation
package(October1986)was an essentialstep in providing
producerswith access to competitivelypriced good quality leather. Footwear
producers response to this opportunityare borne out by the rapid growth in
leather imports over the past two years (see Table 3.13). Of more concern,
has been the simultaneousprovision of indirectsubsidieson inputs to leather
product producers (includingleather shoes) in the form of a ban on exporting
hides and a tax on semi-processedleather. One integrateddomestic
manufacturerof leather shoes and bags, who is also involvedin tanning,
estimatesthat these policieshave reduced the price of inputs to leather
making by as much as 50 per cent in the past year. It seems likely that
Indonesianleather is now availableto domesticusers at or below world prices
for comparablequality. While this does provide an indirectsubsidy to
footwearmanufacturersit is likely to hamper the developmentof the domestic
leather industryby reducingincentivesto invest in quality enhancinganimal
stock or machinery.

Table3.13: LE&ATMEDIPORTSBY INDONESIA,

1983-1988
(US$'000)

1983 1984 1985 1986 1987 1988

120 81 493 406 1,747 9,050

Source: Central Bureau of Statistics-

Imports,Various Years.
 - 79 -

3.45 Aside from the negative impact on the incomes of domestic leather
producers,the extent to which this subsidizationhas assisted exportersis
not clear. While one small manufacturerof leather shoes, exportingproducts
in the low to medium quality range to Europe and the Middle East, stressedthe
adequacy of domestic leatherquality for his products, large manufacturers
pointed out that much of the shoe export boom has been associatedwith
internationalbrand names resourcingto Indonesia. Such brand names often
iictatecomplete shoe specifications,includingall material inputs and, at
the top end of the market, insist on entirely importedleather. One large
domesticmanufacturerindicatedthat for manufacturersnot entirely
specializedfor export, shoes for the domesticmarket would be producedusing
largely domestic inputs while export markets would often be sourced from
impottedmaterials.

3.46 Given this behaviorand the effect of P4BM discussedbelow, it would

appear that the main beneficiariesof these subsidieshave been domestic
tanneriesand leather shoe manufacturersproducing for the domesticmarket
rather than for export. These producersare also in receipt of some of the
highest tariff protectionin the manufacturingsector. This combinationof
subsidizedinputs and high import tariffs on outputs,produces the high
effective rates of protectionfor footwearreferredto earlier. As a result,
the traditionaldomestic shoe industry is not being directlyencouragedto
restructuretowards being a more efficient and low cost producer. In
addition, domesticconsumershave o.3t directlybenefittedfrom the increased
competitivenessof the Indonesiafootwearindustryvia lower prices, and
domestichide and semi-finishedleatherproducershave incurreda significant
loss.

3.47 Since its inceptionin May 1986, the BAPEKSTA facilityhas played a
crucial role in supportingthe growth of exportswhich has dominated the
industryover the past two years. The widespreaduse of the facility is
reflectedin the fact that about 77Z of footwearexports utilize inputs
importedthrough BAPEKSTA. With average duties on importedinputs in the
range of 302 to 402, the cost saving resultingfrom gaining duty exemption is
significant. While cheap Indonesianlabor has been a powerful impetus to
resite productionfrom other neighboringcountries,access to inputs at world
prices was considerto be a more importantfactor by many firms.15/ Given
that labor costs probablyaccount for between 101 to 202 of non-fuelmaterial
costs, it is easy to overstatethe importanceof cheap labor when compared
with the cost saving associatedwith being exemptedfrom import duty.

3.48 The level of import tariffshas been, and remains,high for footwear
products (see Table 3.14). In an economy which has, by developingcountry
standards,a moderate average tariff rate on manufacturedimports,footwear
tariffs remain well above the average. Whereas the 1985 reform brought a
significantdecline in the average level of tariff protection,there was a

151 It was estimated that Indonesianlabor cost are about one-tenthof

those in Korea, and ;roductivitywas about two-thirdsafter 2 years
on-the-jobtraining.
 - 80 -

marginal increasein the footwear tariff. This partly reflectedthe use of

specificduties rather than ad valorem tariffs for some footwearproducts.
Although there was some decline in tariffs up to 1988 (due primarily to the
effect of the devaluationon specificduties) this trend has been reversed
under the 1989 HarmonizedSystem. In the current tariff schedule,the
combinedeffect of both the high ad valorem tariff and surchargeshas been to
raise the overall level of nominal tariff protectionto about 702. compared
with an average for the manufacturingsector of about 25?.

Table 8.14: AVERAEFOOWEAR TARIFFRAIES- 186 TO 1989

Pre-1985 Post-1986 1988 1989

Footwear Manuf. Footw"r Menuf. Footwear ManuT. Footwear Menuf.

Production-weighted tariff 64 27 66 19 52 16 s6 21
Surcharge 0 0 0 0 0 a 14 4
Unweightodt..iff 62 a8 67 28 48 24 s8 27
Surcharge 0 0 0 0 0 1 18 1

Source: Bank staffcalculations.

3.49 Both the high specificduties in the pre-1988tariff structureand

the incidenceof surchargesin the current HarmonizedSystem tariff schedule
have focused on protectingdomesticleather shoe producers. As noted above,
these producers also receive an indirect subsidyvia the ban on unprocessed
leather and export taxes (up to 502) on semi-processedleather. The only real
pressureon domesticoriented firms to increaseefficiencyhas come through
domestic sales from exporters. While this has lowered domesticprices for
some shoe types, the domesticmarket is receivingshoes at the low quality end
of the spectrum (some rejects)at prices above internationallevels.

3.50 There seems little doubt that firms with appropriatetechnology,

Indonesianlabor, and material inputs at world prices can effectivelycompete
on world markets. The more efficientdomesticfirms appear eager for joint
venture relationshipsand the technicalexpertise and market entre
accompanyingthis. Reductionof the very high tariffs (with surchargeremoval
a priority) on outputs,combinedwith the removalof remainingNTBs and lower
tariffs on inputs (i.e. PVC, nylon cloth),would encouragethe further
restructuringof the industry. Such an evolutionwould seem preferableto the
present situationwhereby internationalcompetitive (and pressureson domestic
firms to restructure)is dependanton the continuedefficiencyof the BAPEKSTA
facility.
 - 81 -

E. PAPER

3.51 Indonesia'spaper industryhas been stronglyinfluencedby the trade

regime. At the start of the decade, the industryprimarilyproduced
"downstream"paper and paper products for the highly protecteddomestic
market. Low or zero tariffs on inputs (i.e.,pulp and waste paper) and high
tariffs on final products, reduced incentivesto build integratedpaper mills
which utilized Indonesia'slarge forestryresources. By the end of the
decade, however, the growing importanceof export markets and less protection
on the domesticmarket have encouragedthe industryto restructureitself.
The need to become more price competitivehas led to larger more integrated
paper-makingplants. One of the interestingaspects of the paper industries
developmenthas been the growth of an efficientdomesticpulp industry,
without recourseto import tariff or NTB protection.

Recent Performance

3.52 The paper industry is one of Indonesia'sfastest growing industries,

expandingby 382 p.a. between 1983-86,and 512 p.a. between 1986-88. This
growth has occurred across a range of paper products,with particularlystrong
growth in HVS oaper (see Table 3.15). Initially,much of this growth derived
from import-substitution for final paper products. Imports as a share of
total domesticoutput declinedfrom about 882 in 1983 to 342 in 1986. Since
then, the nominal dollar value of importshave increased,with the primary
source of growth for the domesticpaper industryswitchingto the export
market. Total dollar export earnings increasedfrom US$33.3 million in 1986
to US$138.7 million in 1988, resultingin the ratio of exports to domestic
productionrising from 7.02 in 1986 to 21.5Z in 1988 (see Table 3.16). Most
of Indonesia'sexport growth has been orientedtowards regionalmarkets,
particularlythe large printing and publishingcentre of Hong Kong.

Table 3.15t PAPER AND PAPER PRODUCTSOUTPUT

1983-1988

Current Prices (Rp.billion) Real Growth (Z p.a.)

1983 1986 1988 1983-86 1986-88

Paper 123.3 373.2 1,187.2 37.3 64.3

Paperboard 1.2 7.0 12.7 70.1 23.8
Containers/Boxes 27.2 78.3 110.7 35.3 8.3
Other Products 29.2 94.7 176.0 40.9 25.0

Total 181.0 553.2 1,486.5 38.1 50.8

Source: BPS and World Bank staff estimates.

 - 82 -

3.53 The industryhas expanded from about 30 paper mills in 1983 to 40

paper mills, 15 of which are now integrated. Installedcapacityhas more than
doubled,with utilizedcapacity increasingfrom a low of 59Z in 1985 to 80Z by
1988. Approximatelya third of this capacity is in the public sector, but
most of the recent expansionhas occurredin the private sector. Foreign
joint-venturesand some merging of existingprivate firms have been a feature
of recent developmentsin the industry.

3.54 Another importantrecent developmenthas been the rapid expansion in

domesticpulp making capacity. In the early 1980s, the paper making industry
was heavily reliantupon importedpulp. From 1985 the expansion of existing
pulp capacity and the establishmentof new pulp making plants has resulted in
pulp imports as a ratio of domesticproductionfallingmarkedly (see Table
3.16). This has led to increasedintegrationof the paper making industry,
which due to both scale and quality effects has made Indonesianproducersmore
price competitive. Industryexperts suggest that Indonesianwood pulp
productioncompetes favorablywith Australiasianproducts, and is being
produced at higher quality utilizingmore recent technologyand cheaperwood.
Neverthelessone of the issues that has delayed the establishmentof
integratedmills, i.e., access to clear land title for a commerciallyviable
time period, continues to slow the furtherexpansionof the industry.

Table 3.16: PAPER AND PAPBR PRODUCTSt

EBPORTS AND IMPORTS,1983-1988

Current Prices (US$ million) Real Growth (Z p.a.)

1983 1986 1988 1983-86 1986-88

Exports
Paper 5.6 32.- 128.1 70.9 82.1
Paper products neg 0.6 10.6 108.3 297.4

Imports
Paper 159.2 97.7 114.5 -19.1 -0.4
Paper products 15.1 30.0 40.2 19.7 6.4

Exportsloutput 2.9 7.0 21.5

Importsloutput 87.5 34.4 24.0

Memo Item
Pulp and wastepaperas
Z of paper output 69.0 35.0 29.0

Source: BPS and World Bank staff estimates.

 - 83 -

Effects of the Trade Regime

3.55 The paper industrydevelopedin the 19708 and early 1980s behind a
highly dtstorted pattern of import tariff protection. Basic inputs into paper
making were placed under a relativelylow 101 import tariff, while major paper
productswere protectedby tariffs of 602.16/ Although the high tariffs on
paper productswere cut by a half in the 1985 tariff reform package (see
Table 3.17), the reductionin protectionwas offset by a nrcliferationof
import license restrictions. Thus the industrycontinued to expand behind
high tariffs supplementedby NTBs. A World Bank subsectorstudy in 1986,
reportedthat only 9 of 30 paper mills were integratedand that the industry
was generallyuncompetitive. At that time (i.e.,based on 1984 data), the
estimated implicit subsidyprovided to non-integratedmills was 712, compared
to 432 for integratedmills. White newsprintwas the most competitive,with
an estimated implicit subsidy of 17X.

Table 3.17: TARIFFS ANDSURCHARGESs

MAJORPAPER ANDPAPER PRODUCTSITRIS

Pre Post Post 1988 1989

Product 1985 1985 1986 (+surchg) (+surchg)

White Newsprint 20 5 5 5 5
HVS 60 40 60 30+5 35+5
DuplicatingPaper 60 30 50 30+5 30+5
Coated Writing/
Printing Paper 60 30 60 30+5 30+5
Kraft Liner 60 30 60 30 30
Sack Kraft Paper 60 30 30 30 30/a
S.C. Fluting Paper 60 30 60 30+5 30+5
CigarettePaper 60 30 30 30+5 30+5
Paper Board 60 30 30 30+5 30

La Other than for cement bags, where the rate is 5 per cent.

Source: World Bank, RSI Data Base.

3.56 Since 1986, the industryhas graduallybeen exposed to more

competition. First, most import license restrictionswere removed in October
1986 (except for newsprint)and replacedby (higher)import duties. Second,
import duties were progressivelyreducedbetween 1986 and 1988 towards a
target of 302. Import protectionon inputs (waste-paperand pulp) also

16/ The exceptionwas 'whitenewsprint',which was already covered by a

special import license restriction.
 - 84 -

underwent some changes. While the tariff on pulp was lowered (from 102 to 52,
and then to 0 for some pulp types), the tariff on waste newspaperwas raised
to match a relaxationof import license restrictions. As with paper pl:oducts,
this tariff increasehas been subsequentlyremoved (see Table 3.18).

Table 3.18% TARIFFSsMAJOR PAPER-MAKINGMATERIALS

Product Pre 1985 Post 1985 1988 1989

Waste Issued Newspapers 10 40 0 0

Other Waste Paper 10 40 40 0
MechanicalWood Pulp 10 5 5 5
ChemicalWood Pulp 10 5 0 0

Source: World Bank, RSI Data Base.

3.57 The growing importanceof the export market coupled with the move to
a 302 import duty (withno NTB protection),has encouragedthe industryto
restructure. Given that che 1986 Bank study estimatedthat the minimum
implicit subsidy for small mills was 342, it seems likely that many of these
smallermills have increasedefficiencyto survive under a 30S import duty.
The recent BPS industrialsurvey indicatesthat some smaller firms have
invested in pulp making machineryto lower costs via vertical integrationand
increasedcapacity,while others have merged. The increasein competitive
pressure has also resultedin a lobbyingof the governmentfor surcharge
protection,which so far has been restrictedto 52 or,some nroducts. At the
same time, it would appear that the larger more integratedmills are receiving
tariff induced quasi-rentson that proportionof their output sold on the
domesticmarket.

3.58 Firm level interviewsindicatedthat the 1986 devaluationplayed a

major role in increasingthe industry'sinternationalcompetitiveness. In a
sense the devaluationratifiedthe large expansionin capacitythat had
occurredbetween 1982 and 1988 by allowingthe most efficientIndonesian
producers to export at a profit. Industryfigures show an increasein
capacityutilizationfrom 631 in 1986 to 842 in 1988.

3.59 Overall the industryis in a state of transition. While some firms

have modernizedto take advantageof Indonesia'spotential international
competitiveness,other firms have done just enough to remain competitlveon
the domesticmarket. The general feeling in the industry is that a lowering
of tariffs below 302 would cause many of the smallernon-integratedproducers
out of businessor encouragethem to invest in new plant, perhaps specializing
in particularproducts. Nevertheless,most of the larger firms could compete
with lower tariffs,as is evidencedby the rapid growth in exports.
 - 85 -

CHAPTER4

ACTIVTIES
UBm CTS OF THE TRADE REGIMEON SELECTEDAGRICULTURAL

A. Introduction

4.01 Agricultureplays a central role in the Indonesianeconomy,

accountingfor almost a quarter of GDP, about 38Z of non-oil exports, and
employingabout 55? of the labor force. After strong growth of 42 p.a. in the
late 1970s and early 1980s, tae agriculturalgrowth rate has begun to slow.
With the expansion in rice output unlikely to match past levels, attentionhas
focussedon encouragingthe developmentof a more broad based and diversified
agriculturalsector. This has raised many issues related to the network of
administrativecontrolsand price interventionsthat GOI currentlyuses to
direct agriculturalproduction. Trade policy is one of the major policy
instrumentsthroughwhich GOI intervenesin agriculturalmarkets.

4.02 internationaltrade in Indonesia'sagriculturalproducts is more

highly regulatedthan trade in industrialproducts. While the share of
domestic productionprotected from import competitionthroughNTBs is similar
' both sectors (about 402), agriculturediffers from manufacturingin that
:en egriculturalexports are also regulated. However,despite the prevalence
of trade restrictions,the aggregatelevel of protectionprovided to
agricultureis lower than that for manufacturing.l/ Put another way,
agriculturalprices depart less, on average, from free trade prices than those
in manufacturing. This primarily reflectstwo importantcharacteristicsof
the trade regime as it pertains to agriculture. First, althoughinternational
trade in rice is highly restricted,domestic rice prices have been maintained
close to world prices.2/ Given the weight of rice in total agricultural
production (about 65Z), this lowers production-weighted estimate of
protection. Second, some of the importanttrade interventionsin agriculture
result in a tax on domesticproducersrather than providingassistance
(e.g., edible oils, wood, leather,rattan, and rubber). This is rarely the
case in manufacturing.

1/ The average effective rate of protectionfor agricultureis 211

compared to 73? for manufacturing. However, it should be noted that,
in contrast to some other oil surplusnations, GOI have channeleda
large share of direct public investmentinto agricultureto offset the
bias in the incentivestructure.

2/ It should be noted that the internationalmarket in rice is small in

relation to world production,and that any lar3e participationby
Indonesia (eitheron the import or export side) would influencethe
world price.
,]
 . 86 -

4.03 While the aggregate level of protectionfor agricultureis low

relative to manufacturing,there is an almost equallywide dispersionaround
this average. Thus, while many agriculturalproductssell at close to world
prices, others trade well above (or below) importlexportparity. The first
part of this Chapter identifiesthe most importanttrade policy interventions
for both imports a&A exports. The overall conclusionis that suhstantial
economic gains would result from relaxingand simplifyingthe current
restrictionson the internationaltrade of agriculturalcommodities. More
specifically,the removal of NTBs and loweringof import tariffs on
agriculturalcommoditieswould improve the allocationof agricultural
resources,increasecompetitivepressureson traders and producers,and
benefit domestic consumers (see paras. 4.10 to 4.14). This should be
accompaniedby a review of the current coverageof export regulations. Where
appropriateexport restrictionsshould be removed. In those rare instances
when export restrictionsare in Indonesia'sbest interest,the primary issue
is to design the policy interventionso as to minimize the negative effects on
producers (see paras. 4.18 to 4.24). In regulatingexports, it is also
importantnot to reduce domesticcompetitionby creatingdomestic barriersto
entry into either trading or producingagriculturalcommodities. While an
export tax is preferableto other forms of export regulation,where a quota is
used it is importantto utse& transparentand efficientquota allocation
mechanism.

4.04 The second part of the Chapter presentsan analysisof how the
current trade regime effects the productionof some processed food products.
These products are examinedbecause it is an area where Indonesiais thought
to have a potential comparativeadvantageand the governmentis keen to
encourage further growth. The analysis shows that the current trade regime U
provideshigh levels of protectionon both importantinputs (e.g., tin plate,
sugar and tetrapak)and outputs (processedmeat, fruit and vegetables). As a :
consequence,it is primarilvthe larger firms that can compete on world
markets because they are capable of using the import duty exemption and export
credit facilitiesto access inputs at world prices. Smaller-scaleand
indirect exportersare disadvantagedthe most by the current trade regime
because they have much more difficultyavoidingthe high cost of imports.
Producers for the domesticmarket are able to absorb high input costs due to
the correspondinglyhigh tariff and NTB protectionon final processed food
products. However, domesticdemand for these products is lower than it would
be at internationalprices and these firms are not competitiveon world
markets.

D. AgriculturalImports and the Trade Regime

4.05 During the first stabilizationperiod (1982-85),the nominal value of

agriculturalimports fell by almost a third as a result of the government's
efforts to reduce externaland iaternalimbalancesfollowingthe decline in
oil prices (see Table 4.1). While most of this adjustmentwas achievedby
correctivemacroeconomicpoliciesand solid gains in domestic rice production,
 - 87 -

T 4.1: AG4ICULYAL INPOlYS BY COOMODITY 98S - 1988

(millia. of US dollars)

1983 1984 1985 1986 1987 1988

Food & beverages 1,263 902 708 770 866 1,049

Live animals 15 12 8 18 26 27
DaiLy products 91 70 65 56 53 75
Wheat 334 276 259 272 244 229
Rice 384 132 9 6 12 9
Corn 5 10 7 6 25 8
Vegetables 35 22 18 26 26 60
Sugar 134 2 4 19 31 40
Feedstuffs 71 101 87 130 133 127
Beverages 8 4 4 6 4 5
Tobacco & products 20 25 17 22 29 29
Oilseeds 89 145 96 114 113 162
Vegetable oil 12 52 36 18 97 207
Other 68 51 98 77 73 71

Non-food 331 426 315 345 493 593

Wood pulp 138 184 96 152 207 268
Cotton 175 214 180 172 266 302
Other 18 28 39 21 20 23

Total 1,594 1.328 1.023 1A115 1,359 1.642

Source: Central Bureau of Statistics.

import demand was also suppressedby the increasinguse of NTBs. Over this
period most of Indonesia'slargest import items became restrictedto
particulartraders,partly in an effort to broaden the move towards
self-sufficiency beyond rice (e.g., to include sugar and soybean). Since
1986, however, the faster rate of economicgrowth coupled with the move
towards deregulatingtrade (particularlyBAPEKSTA),have reversedthis trend,
with the nominal value of agriculturalimports increasingfrom US$1.1 billion
in 1986 to US$1.6 billion in 1988.

4.06 Although the deregulationmeasures taken to date have not focussedon

agriculturalproducts, there are a few importantexceptions. Cotton was
deregulatedto assist the growth of the textilesindustryand over 100
processed food items, that were formerlyrestrictedto the STCs, we-e moved
off the RestrictedGoods List. More recently,BULOG's import monopoly on corn
has been removed,allowingprivate traders to import. In addition,the duty
exemption and drawback scheme (BAPEKSTA)has provideda useful mechanismby
 - 88 -

which some producersof ptocessedagriculturalproductshave been able to

avoid trade restrictions. Nevertheless,agriculturalimports (particularly
consumptionitems) have grown at a slower pace since 1986 than almost any
other import category. This reflectsthe continuedprevalenceof trade
restrictionsand above average import tariffs.

4.07 Food importsare highly regulated,with most major products being

restrictedto BULOG and the STCs (particularlyKerta Niaga and Tjipta Niaga).
BULOG holds the exclusiveimport rights for rice, wheat, wheat flour, sugar,
soybeans,and soybeanmeal. Imports of these productsaccount for about half
the value of Indonesia'stotal food imports. The STUs hold the import rights
for a range of more processed food products,mostly tinned fruit, vegetable
and meat products. These trade restrictionshave been a contributoryfactor
in encouraginga misallocationof agriculturalresourcesinto low return
activities,such as sugar, in which Indonesiahas no comparativeadvantage.
In addition,trade restrictionshave supportedhigher consumerprices for a
range of agriculturalconsumer goods includingwheat, sugar, edible oils, and
processed foods.

4.08 In the case of rice, having attainedself-sufficiencyin the early

1980s, GOI has been reluctantto continueto use internationaltrade. In 1984
and 1985, with total rice productionexceedingdomesticconsumption,GOI
allowed a large build-up of stocks, restrictingexports to a minimum. This
impcsed high stock costs on BULOG and made it difficultto maintain rice
quality due to low stock-turnover. Since 1986, two successiveyears of below
average rain fall have reversedthis situation,with the growth in domestic
rice output fallingbelow consumptiontrends. Although BULOG was able to
drawdown stocks to partially compensatefor the supply shortfall
(1.8 million tons excludingallocationsto budget groups), this was not
sufficientto prevent a marked increasein rice prices. For example, the
retail price for medium-qualityCisadane rice increasedby 22 percent in 1987
and a further 26 percent in 1988. During this period Indonesianprices were
more volatile than world prices,with domesticprices for some rice types
exceedingcyclicallyhigh world prices by early-1988.

4.09 Higher rice prices also reduced the %;.=nd for non-food agricultural
productsbecause of the inelasticdemand for rice and the large share of rice
(172) in the consumerbudget. With access to imports restricted,the burden
of maintainingself-sufficiency was carried by consumersvia higher rice
prices. The negative effect on real incomeswas particularlymarked for the
urban poor and landlesslaborers. Although the governmenthas respondedby
allowing some imports,the recent experiencewith rice illustratesthe dangers
of severingthe link with internationalmarkets. Even a large public stock of
3.5 million tons (builtup in the 1984-85 period) proved insufficientto
offset the deficit caused by the 1987 drought and subsequentweak recoveryin
rice production. One alternativeapproachexploredin Chapter 5, would be to
auction a fixed import quota for rice to the private sector. This would
reestablisha more direct link with world prices, exert competitivepressures
on BULOG and producers (in terms of price and quality),and provide a useful
safety-valueduring periods of below trend productionlevels. This would
still allow BULOG to play the role of stabilizingdomesticprices by market
interventions.
 - 89 -

4.10 The resourceallocationand consumer'scosts of existingtrade

restrictionsare probablyhighest for sugar and soybean. In the case of
sugar, BULOG makes up for the domesticshort fall in productionby importing
through foreign agents. BULOG's sugar purchasesare made through direct
negotiationswith these agents rather than by using open international
tenders. According to trade sources,BULOG pays commissionsof up to
US$15 per ton as comparedwith average commissionsof less than US$1 per ton.
The final cost of sugar in the Indonesianmarket in 1989 was maintainedat
close to 40Z above the import parity price to protect the high cost domestic
sugar industry. In the cuse of soybean and soybeanmeal, BULOG has
periodicallyallowed private importersto import soybeanmeal under a special
license. In 1988, however, this facilitywas withdrawn,in order to protect a
new soybean crushingplant (PT. Sarpindo). Currently,BULOG import soybeans
which are then crushed by Sarpindo. Sarpindo is paid Rp. 20 per kg to crush
the beans and is allowed to keep the resultingsoybean oil.3/ The meal that

Table 4.2: COMPARATIE RETURNS TO FOODCROPPRODUCTION,1987

Crop/location Yield Net Returns /d

(Kg./ha) ('000 Rp./hectare/season)

Irrigated rice /a 7,000 958

(Klaten,C. Java)
Corn lb 4,200 395
(Kediri,E. Java)
Soybeans 1,400 370
(Kediri,E. Java)
Sugarcane /c 8,000 186
(Kediri,E. Java)

/a Gabah = rough rice

/b Dry hulled kernels
/c Net return to sugarcanecalculatedas return on 18 month croppingcycle
convertedto 3 1/2 months so as to be comparablewith other crops.
/d Net returns refer to the differencebetween the gross value, at farm
prices, cash costs and an implicitcharge for family labor and capital,
all at economic prices. Net returns includesprofits and returns to
land. Calculatedon basis of irrigatedland cultivatedby progressive
farmers.

Source: Food ResearchInstitute,Rural Income and EmploymentEffects of Rice

Policy in Indonesia,prepared for the Ministry of Agriculture,
October 1988.

3/ Assuming a domestic soybean oil price of Rp. 700 per kg and that a ton
of soybeansyields 842 meal and 161 oil, Sarpindo receiveUS$73.00per
ton for crushingthe oil. This is very high by international
standards.
 90 -

Sarpindoproduces is sold by BULOG on the domesticmarket at a US dollar

equivalentprice of about US$321 per ton. Althoughmeal prices have
fluctuatedsince Sarpindobegun operation,the average CIF price of imported
meal in the first 6 months of 1989 was about US$275 per ton.

4.11 The high domesticprices of sugar and soybeanmeal have two major
effects. First, consumers (includingthe downstreamfood processing industry)
pay a higher price for these products than they would if trade was not
restricted. This has diminishedthe competitivenessof agro-processing,for
which sugar is an importantinput, and raised the cost of feed to the
livestockindustry. Second, distorteddomesticprices have encouragedfarmers
to grow sugar and soybean on land where this may represerntan inefficientuse
of agriculturalresources.4/ Table 4.2 providesan estimateof the
comparativereturns to major foode:opswhen all inputs and outputs are priced
at their economicvalue. As shown, the use of irrigatedland on Java to
cultivate sugar is an inferioruse of resourcesthan cultivatingany of the
other crops. The low returns to soybeansand corn relativeto rice shown in
Table 4.2 reflect both the inferiortechnologicalpackage used for these crops
and their use as rotationcrops with rice. The rotationof corn and soybeans
with rice may prevent pest attacks and improve rice yields.

4.12 Wheat imports,which account for over one fifth of all food-imports,
are also restrictedto BULOG. Except for purchasesmade under the PL-480
program, BULOG purchaseswheat in a similarway as sugar and soybean,through
directly negotiatedcontracts. The wheat is then sold to PT. Bogasari at a
fixed price (usuallybelow the world price) for milling. Bogasarithen sell
the flour to licenseddistributorsat a price determinedby BULOG. Part of
the sales revenue is returnedto BULOG, with Bogasariretaining its fixed
milling fee plus the bran by-productwhich results from milling. The
differencebetween Bogasari'spurchase and selling price (includingthe value
of the bran) has been estimated as US$116 per ton. By contrast,milling costs
in the United States,where labor costs are much higher, are between US$35 and
US$45 per ton. Given the trade restrictionson importedwheat flour, the
resultinghigh cost of locallyproducedwheat flour reduces the
competitivenessof a range of food processingindustries(e.g., bread and
noodles) and taxes consumers.5/

4/ It should be noted that trade policy is not the only instrumentused to

encourage domesticproduction. 'Productiontargets"have also been
employed to induce farmers to produce sugar and soybean.

51 The high cost of wheat also has resourceallocationeffects,by

indirectlyincreasingthe demand for wheat substitutes- primarily
rice. Lower wheat prices would, dependingon the cross-price
elasticities,reduce the demand for rice, making rice self-sufficiency
easier to attain at the same time as freeing agriculturalresourcesfor
use in alternativecrops. The extent to which resourceswould be
switchedinto other crops depends on relativeprofitability.
 - 91

4.13 Another importantimportedfood item is vegetable oil, which has

expanded from US$18 million in 1986 to US$207 million in 1988. This rapid
growth coincideswith the gradual relaxationof import controls,culminating
in the complete removal of license protectionduring 1988. However,an import
tariff of 307 was imposed on refinedvegetable oils. Although Indonesiais a
major producerand exporterof crude palm and coconut oil, the tariff on
refiv.adoil has been imposed to protect the high cost domestic refining
industry. Before deregulation,imports of refinededible oils were restricted
to a few designatedtraders,where the most importanttrader was also the
largest single domesticproducerof refined edible oil. This firm has been
able to maintain its dominanceof the import trade, by teing allowed an
exemptionfrom the 302 import duty. Thus, while the removal of license
protectionhas been a progressivestep, the impositionof a fairly high tariff
has maintainedhigh domesticedible oil prices for consumersand reduced the
pressure on domesticedible-oilrefinersto increaseefficiency.

4.14 Most of Indonesia'sother food imports are relativelyminor in value

terms, partly because of the prevalenceof informalquotas. Dairy product
imports are limited to a few companies,as are tobacco imports. The bulk of
the remainingfood imports are restrictedto the STCs, particularlyKerta
Niaga and Tjipta Niaga. The STCs hold restrictiveimport licensesfor about
300 items, most of which are processedvegetable,meat and fruit products.
While the STCs do import directly,they also allow private firms to import for
a fee of between 32 to 52. Interviewswith the STCs indicatethat the
Hinistry of Trade often imposes a quota on the total value that the STCs can
import. Although these quotas are not published,the STCs ensure that private
importersdo not exceed the overall allocation. In the November 1988
deregulationpackage,GOI took the first step in reducing these restrictions
by removingabout 100 processed food items from the RestrictedGoods List.
The price effects of this reform were moderated,however, by the impositionof
high import duties. Over half of the productsderegulatedin November 1988
have been accordedan import tariff (includingsurcharge)of over 502.

4.15 Non-food imports have grown at about twice the rate of food imports
reflectingthe strong growth of the domestictextilesand paper industries.
This rapid growth has resulted in increased demand for imported cotton and
wood pulp.6/ In the case of cotton, the expansion of the textiles industry
has been accommodatedby a complete relaxationof trade restrictions. In
1986, cotton importswere shifted from the approvedimportercategory to the
more open IP license category.7/ This enabled domestic fabric producersto
import cotton directly. In January 1987, cotton importswere deregulated
further by being moved off the RestrictedGoods List and classifiedas under
the IU non-restrictivelicense category. The effect of this reform was
moderated,however, by the requirementthat importerspurchase 1 ton of local
cotton for every 10 tons of importedcotton. Because of the limited supply
and inferiorquality of domesticcotton this restrictionwas lifted in
November 1987. The relaxationof trade restrictionson cotton has been an

6/ See Chapter 3 for a detaileddiscussionof the textile and paper

industries.

see
7/ For definitionof license types and degree of restrictiveness,
Chapter 2.
 - 92 -

important factor underpiningthe rapid growth in Indonesia'stextile industry.

Total textile exports increasedfrom US$0.8 billion in 1986 to US$1.7 billion
in 1988. Interviewswith textile producersconfirm the importantrole that
having non-restrictedaccess to cotton has played in allowing them to maintain
their price and quality competitiveness.

4.16 Wood pulp importshave never been under a restrictivelicense. The

expansion in impotts reflectsthe growth in paper and paper products exports
at a rate of over 1002 per annum since 1986. Indeed, the ratio of imports to
output in the paper industryhas declinedsubstantiallydue to the expansion
of the domesticpulp industry. As noted in Chapter 3, the domesticpulp
industryhas developedwithout NTB protectionand with a low import tariff of
52 on importedpulp. The developmentof an efficientdomesticpulp industry
has been crucial in enablingpaper product producersto compete on world
markets.

C. AgriculturalExports and the Trade Regime

4.17 The performanceof Indonesia'sagriculturalexports has been mixed,

reflectinga combinationof strong output growth for some products (e.g.,
shrimp, wood) and wide price swings for others (coffee,rubber and spices).
For some products, Indonesiais one of the world's largest suppliers. Trade U
in agriculturalexports is highly regulatedwith about 402 of export value -
directly affectedby some form of regulation.8/ These trade regulationsare M
intendedto achieve a range of objectivesincludingtaking advantageof _
Indonesia'slarge market share, encouragingdomesticprocessing,meeting
domestic requirementsand conservingscarce resources. The trade deregulation
measures taken since 1985 have not focussedon agriculturalexports and, with
few exceptions,there has been an increasedincidenceof products that are
either banned (e.g. rattan),heavily taxed (sawn timber),or restrictedto
approved exporters (plywood,CPO, CCO and copra). An exceptionto this trend
is pepper, which was removed from the approval exporterlist in October 1989.9/

4.18 Indonesia'sfood exportshave doubled in nominal terms since 1983,

with most of the increasedearningsderivingfrom shrimp,vegetablesand
vegetable oil exports (see Table 4.3). The rapid growth in shrimp exports
occurred after the reorientationof productionaway from ocean shrimp towards
in-land pond productionin the early 1980s. There are no export restrictions
on shrimps,and a loweringof the import tariff on shrimp feed-mealsince 1986
has increasedprofitability.l0/Many of Indonesia'sother food exports

8/ See Chapter 2, para 2.23 to 2.33, for a discussionof these

regulations.

9/ The quota restrictionson coffee have also been lifted followingthe

collapse in the I.C.A. agreement. Nevertheless,it would appear that
coffee exports must still be channeledthrough approvedexporters.

10/ There are quality controlson exports,but private traders are

primarily self-monitoring.
 - 93 -

(includingvegetable oils) are regulatedthrough a system of export licensing

or "approvedexporter" arrangements. This system restricts the right to
export to designatedtraders approvedby the Ministry of Trade. The number of
approvals is often limited,and once the initial list of approvedexporters
has been decided upon, it is difficultfor new entrants to gain access.
Usually these licensingproceduresare determinedin close collaborationwith
the commodity trade association- and in many cases membershipof the trade
associationis a prerequisitefor acquiringapprovedexporter status. For
food exports,approved exporterregulationsapply to cassia vera, nutmeg,
tengkawangseeds, vegetablesfrom Sumatra,vanilla, and coffee.

Table 4.3: AGRICULTURALEXPORTS BY COMKODITY 1983-88

(millionsof US dollars)

Product 1983 1984 1985 1986 1987 1988

Food and beverages 1,304 1,592 1,851 2,011 2,054 2,613

Fish 20 15 19 24 45 84
Shrimp 204 202 207 297 369 528
Vegetables 35 40 53 60 101 151
Fruit 7 13 22 23 29 37
Coffee 430 568 562 822 539 552
Cocoa 42 53 64 61 66 82
Tea 120 226 149 99 119 125
Spices 94 112 126 209 240 222
Feedstuffs 86 65 65 72 74 89
Tobacco 47 43 49 68 71 65
Vegetable oil 148 175 414 166 290 539
Other 71 80 121 110 111 139

Non-food 1,335 1,465 1,109 1,140 1,579 1,914

kubber 848 952 718 713 961 1,246
Wood, lumber 348 366 244 281 416 534
Crude vegetable fiber 122 110 112 118 192 124
Other 17 37 35 28 10 10

Total 2,639 3,057 2,960 3,151 3,633 4!527

Source: Central Bureau of Statistics.

 - 94 -

4.19 Other food products fall under the classificationof 'Supervised

Exports". These include,vegetable oils, salt,wheat flour, soyabeanand
rice. The primary objective is to ensure a sufficientsupply for the domestic
market at reasonableprices. In effect an informalquota, or sometimesa tax,
is imposedwhich varies in its restrictivenessand how clearly it is defined.
In the case of vegetable oils, state-ownedestatesmust market their entire
output through JMOs, which then allocate the edible oil between the domestic
and foreignmarket. A share of private sector output is also channeled
through JMOs. The overall allocationfor export (includingprivate sector
exports) is determinedby the Ministryof Agriculturein collaborationwith
the Ministry of Trade.ll/

4.20 The degree to which the currentmix of policy instrumentshas

achieved GOI's objectivesvaries across products. Generally speaking,for
those goods subject to externalquotas (currentlyonly tapioca)or where
Indonesiahas a large enough market share to influenceworld price
(e.g., plywood and to a lesser extent rubber) some form of government
interventionmay be appropriate.12/ For those productswhere Indonesiacannot
influenceworld prices (e.g., vegetables,salt, and edible oils) the case for
any type of interventionis weak.

4.21 Where externalquotas have been imposed the primary issue is the
design of an efficientand equitableallocationmechanism. Experiencein
other countries indicatesthat a transparentand simple allocationmechanism
(e.g., public auction)is more likely to achieve the government'sobjectives
of fulfillingthe quota while also making it possibleto identifywho earns
the quota rent. The quota allocationcan be designedto channel the rent to
government,the trade associationor to individualtraders. The important
point is to maintain open entry into productionand trading, so that
competitionbetween buyers allows price signals to reach farmers. This should
encourageboth traders and growers to improve quality,without the assistance
of a governmentquality inspectionservice (see Box 4.1, Allocationof Coffee
Quotas).13/

4.22 Where the primary objectiveis to exploit Indonesia'smarket

position, care needs to be taken to distinguishbetween short- and long-term
advantages. In the short-run,restrictingdomesticsupply may result in an
increase in the world price where Indonesiacontrolsa large share of the

11/ For a comprehensivediscussionof trade and other governmentpolicies

related to the tree crop sector s?e "Indonesia- Strategiesfor
SustainedDevelopmentof Tree Crops' - Report No. 7697-IND.

12/ As discussed in more detail in Chapter 5, even where a country has a

large market share, importantlong-termdynamic effects on both the
supply and demand side should be taken into accountwhen decidingupon
the optimum tax.

13/ For example,the role of JMOs needs to be reviewedas they appear to

pay below market prices to captive supplers (i.e., state owned
suppliers). See World Bank Report No. 7697-IND.
 - 95 -

world market (e.g., nutmeg). If an export tax is used the price gain is
capturedby the Government,whereas, if a quota or domesticpurchasingcartel
is used the price gain is capturedby the quota holder or members of the
cartel. In those instanceswhere a quota is used, there is little
justificationfor limitingaccess to the quota to selectedtraders. This
allows quoter holders to capture all of the price gain, and therefore is
unlikely to benefit smallholderproducers. In the case of a cartel, members
of the cartel can use their market power to capture most of the price gains
and to protect themselvesduring a market downturn (see Box 4.2: The
Marketing of Nutmeg).

4.23 In the longer-run,even an export tax may not be to a countries

advantage.14/ Experiencein other countriesindicatesthat the negative
demand and supply effects of an export tax on agriculturalcommoditiesis
often underestimated. Foreign consumersreduce consumptionor switch to
alternativesuppliers,while producers in low tax countriesare encouragedto
increaseproduction. An export tax also reduces returns to producersof the
taxed commodity,which may slow the pace of technologicalchange and reduce
the incentiveto improve quality (see Box 4.3: Longer Term Effects of Export
Restrictionson AgriculturalCommodities).

4.24 There is also concern that the high rents that are sometiLnes
associatedwith wapprovedexporter"arrangementsare encouragingthe spread of
these restrictionsto commoditieswhere there is even less justification. For
example, trade associationsin the frozen prawn and tapioca industrieashave
begun lobbyingGovernmentfor restrictivearrangementsto limit 'harmful'
domestic competition. It will, therefore,be importantfor GOI to develop a
clear overall policy strategyto respondto these pressures. Such a strategy
should be designed to optimize the economicgains over the medium-term,while
ensuring that producersof the regulatedcommodityare not penalized through
the creationof domesticpurchasingcartels.

D. Case Study. ProcessedFood Products

4.25 The export of processed food products is a relativelynew, but

rapidly expandingactivityin Indonesia.15/ After slow and erratic growth
between 1982 and 1986, exports have quadrupledover the past two years from
US$35 million to US$135 million. It is also an industryin which Indonesia is
thought to be potentiallycompetitiveand one which the governmentis keen to
promote. The direct links with agricultureand the potentialof adding value

14/ For an example of the type of analysisrequiredto determinewhether a

low export tax is in Indonesia'sadvantage,see World Bank Report
No. 7697-IND.

15/ Processed food productsare defined as products that in the process of

preparationundergo a substantialchange in form. Thus, canned
fish/vegetableproducts,refined vegetableoil or instant coffee are
consideredprocessedwhereas frozen shrimp,coffee beans or crude
vegetable oils are not.
 - 96 -

to domestic resourcesare both importantgovernmentpriorities. To

investigatethe effects of recent trade deregulationmeasures and the current
trade regime a case study of selectedprocessed food producerswas undertaken.

4.26 The study was based on interviewswith two of the largest business
groups that are solely involveain exporting,and an equally large third group
that is orientedprimarily towards supplyingthe domesticmarket. In
addition, the preliminaryfindingsof a separate survey of 30 small-scalefood
processorshas been drawn upon. The most importantfindingswere:

o Much of the increase in competitiveness, and hence export growth,

since 1986, has been derived from the depreciationof the real
exchangerate.

o The larger,more well establishedfirms, have gained significantly

from the duty exemption/drawbackfacility,access to subsidized
export credit, and the relaxationof investmentregulations-
althoughthey could increaseexports furtherwith less regulationof
their importedinputs.

o The smaller emerging firms continue to find it difficult to

circumventcurrent import barriers (e.g., for sugar and tin plate),
and are, therefore,hampered in taking advantageof their potential
competitivenesson world markets.

4.27 The two large export oriented food processorsexported a total of

over US$17 million canned fruit and vegetablesin 1988, up from negligible
exports prior to 1985. One of the groups exportsunder its own product name,
while the other relies on marketing its productsunder an internationally
known brand-name. Both groups were attractedto Indonesiaby the low
land/wagecosts relative to alternativecountries (primarilyPhilippines,
Thailandand Taiwan). With domesticinputs accountingfor an average of 60?
of total productioncosts, the devaluationin 1986 significantlyincreased
competitiveness. One of the largest companiesremarkedthat the devaluatien
occurredat a time when they had just started to export, and that it gave them
a useful cost advantage in gaining a market foothold.

4.28 Both groups also stressedthe importanceof the import duty

exemption/drawback facilitywith respect to gaining access to tin plate for
can-making. As explained in Chapter 2, tin plate imports are restrictedto
Krakatau Steel in order to protect the domestictin plate producer. Users of
this domestictin plate indicatethat it is of poor quality and is usually
.sold at significantlyabove (40?) the world price.16/ Both firms have been
able to use BAPEKSTA to import their tin plate or tin-canneeds directly. As
the cost of the tin-plateaccounts for between 30X to 45Z of total production
cost, dependingon the product,being able to access tin plate at the world

16/ In late 1988, importedtin plate was priced at US$710 per ton compared
with the domesticprice of US$982 per ton.
U
 - 97 -

price is a significantsaving. In addition,one company stressed the

importanceof maintaininguniform quality,particularlyif the product is
marketed under an internationalbrand-name.

4.29 Neither of these groups have been able to use BAPEKSTA to obtain
another importantinput - sugar. This is primarilybecause sugar is normally
traded for minimum orders of 12,000 tons, whereas the annual consumptionof
the largest food processiongroup is about 4,000 tons. As users of the
BAPEKSTA facilityare prohibitedfrom selling sugar to other exporters,there
is no choice but to purchase the sugar from BULOG. However,one of the
largest exporterswas able to negotiatea special price with BULOG which
lowered the cost to about 25Z (as opposed to 402) above world prices.

4.30 Both groups have used the PreshipmentExport Finance Facilities

extensively,which has providedcredit at 112 (now 14.52) comparedwith
commercialrates of over 202. In one case this financingwas used to finance
approximately802 of the value of export orders. As both groups are
consideredas very credit worthy by their banks, neither had any problem in
being granted the credit. While gratefulfor this added assistance,at least
one company did not feel that the subsidizedinterestrate made an appreciable
differenceto their competitivenesson world markets. Having access to
credit, rather than the subsidy element,was consideredof most importance.

4.31 The domesticorientedprocessedfood producer, exportedabout 102 of

productionin 1988. The major reason for enteringthe export market was to
establisha market presence to guard against a domestic downturn. As a much
larger proportionof this groups inputs are imported,the devaluationwas felt
to have had a small beneficialeffect on internationalcompetitivenessand,
more importantly,a negativeeffect on domesticdemand. The group reported
that it found BAPEKSTAeasy to work with and that the duty drawback on imports
was essentialif they were to maintainany level of exports. The group also
made full use of subsidizedexport financing. The group did not plan to
extend productionfor the export market much beyond current levels. High
import protectionin the domesticmarket made it more profitableto sell
locally. They also felt that they could not compete on world markets in some
of their major products,particularlywhere other countrieswere seemingly
selling below costs (e.g.,milk products).

4.32 The three firms discussedabove are among the largest and most well
organizedin the sector, accountingfor about 382 of total processed food
exports. They have used their expertiseand creditworthinessto make best use
of the prevailingtrade and financialservicesto increasecompetitiveness.
The survey of 30 smallerprocessed food producerswas designedto determine
whether their experiencein exportingwas similar to these larger firms. The
respondentsto this survey felt that exportingwas good business, and they
wanted to expand their activities. In large part, however, they did not feel
that they have benefittedfrom the deregulationto the same extent as the
larger exporters. Of the thirty firms interviewed,most exportedunder
US$1 million in 1988, the average export level being US$870,000. Most of
these firms were not establishedwith an export orientation. Exportinghad
 - Y8 -

become importantto them, however, increasingfrom 28 percent of total sales

in 1987, to a prcl.'cted
46 percent in 1989. As suc) these firms are
committedto exporting,and are looking for ways to improve their performance.

4.33 Almost universally,smaller exporterscomplainabout their inability

to take advantageof the duty drawbackscheme.17/ As smaller exporters,it is
not financiallyattractiveto manufacturetheir owm cans. They, thus, have to
turn to the more expensive,locally producedcans. Nor are most of these
businessesable to negotiate special deals with BULOG to obtain sugar at cheap
prices. They are forced to buy from wholesalersat prices well above the
world level. For fully refined sugar, the wholesale price can be up to
US$600 per ton, comparedwith an import price of about US$400 per ton. Where
they do have the opportunityto apply for duty drawbacks,smaller businesses
have a great deal of troublewtth the paperworkinvolved. Smaller companies
often find this insurmountable,and do not bother to make an application.

4.34 While large companiesare able to take advantageof the export credit
programs, smaller exportersalso find this more difficult. Bankers report
that many small companiesare not good credit risks. Banks can protect
themselvesagainst default by the exporterby purchasinginsurancefrom the
Bank Indonesiatnder the PreshipmentExport Finance Guarantee Program,but
they have found collectionquite difficult. As a result, bankers have a
tendency to apply very strict rules to the PreshipmentExport Financing
Program, and will restrict it to companieswith proven records of credit
worthiness.

4.35 Both the large and small companies felt that they did not receive
much direct assistancefrom the various government-runexport agencies. The
governmenthad not providedany marketing support,other than a display for
one company at a NAFED181organized trade show. Several respondents stated
that they have approached various government agencies for assistance, but had
not been providedwith any useful informationon competitorpricing or
labellingrequirementsin differentcountries. they also commented that the
quality supervisioncapacityof the governmentlaboratorieewas poor, and that
monitoringand enforcementof regulationswas weak. Finally,many commented
that shippingcosts were a problem,even after the maritime deregulationthat
took place in 1988. There is a shortageof refrigeratedcontainers,which
makes shippingsome processedfood stuffs expensive.

17/ This is less a criticismof WAPERSTAthan it is a comment on the

problemsof using an indirectmechanism to redress price distortions
caused by high import tariffsand NTBe.

18/ NationalAgency for Export Development.

 - 99 -

l l
BOX 4.1 I
ALLOCATION OF COFFEE QUOTAS l

l 1. Indonesia is now the third largest supplier of coffee after

l
Brazil and Colombia, exporting approximately 80Z of total domestic
output valued at US$550 million in 1988. Indonesian coffee is primarily
produced by smallholders, with about 95Z of production on plots of three
hectares or less. The beans are sold through a series of traders from
the village to the provincial level, with provincial level wholesellers l
selling to "approved exporters". It is at this final stage where most
of the cleaning and sorting is done. The techniques employed vary
tremendously from exporter to exporter, some using modern scanning
machinery and others employing hundreds of workers to sort by hand.
Since the quality of the coffee going into this process is poor, exports
are generally Grade 4 under the coffee defects standards.

2. Coffee exports from Indonesia are restricted to approved

exporters. When the International Coffee Agreement (ICA) was in effect, !
an export license with quota was issued quarterly by the Ministry of
Trade. The quota was based primarily upon past export performance,
including exports to non-quota countries. The Miniitry of Trade usually
held about 25Z of the quota in reserve to distribute to exporters that
fulfilled their quota allocation early in the quarter. About 10 of the
coffee quota was held by the six State Trading Companies (STCs), who,
for the most part, were 'briefcase' exporters.11 It is estimated that

l l
1/ 'Briefcase' exporters is a term used to describe those quota holders
that derive most of their income from trading the quota right as
oppose to trading coffee. See Chapter 2. l
l l
lI l
.I
 - 100 _

l l
I l
70 percent of the STCs allocationwas sold to other exporters.What l
coffee they did export was usually of poor quality, reflectingtheir
poor sorting and packing facilities. l
l l
3. Indonesianexports to non-quota countrieshave taken an l
increasingshare of total coffee exports in recent years (see
Table 4.4). Exporterswere encouragedto export to non-quota countries, |
via an incentivecf receivingadditionalquota allocationsfrom the
Ministry of Trade's quota-coffeere3erve. Exports to non-quota l
countries is also restrictedto approvedexporters. The main markets
for this trade is Algeria, Eastern Europe and China. l
l l
Table 4.4: INDONESIACOFE EXPORTS TO QUOTA AND NON-QUOTACOUNTRIES
(thousandsof 60 kgs bags)

I ~~~~~~~~~~~~~~
! Destination 1986/87 1987/88 1988/89 la |

| Quota countries 3,754 3,232 2,237 I

Non-quota countrie3 1,154 1,353 2,905

Total 4,908 4,585 5,142 I

I ,I
I /a Through mid-Februaryonly.

I Source: United States Departmentof Agriculture,Foreign

I AgriculturalSarvice.
I I _
4. In July 1989 the InternationalCoffee Agreement expired and was
not renewed because of disagreementsbetween its two most important |
| members, the United States and Brazil. Breakdownssuch as this have
occurredbefore, and in the past the agreementshave been renewed after
ll _I
l
 - 101 -

l l
a year or two hiatus. Although Indonesiasuspendedits quota system to
coincidewith this, trade has continued to be restrictedto approved l
exporters.2/ Coffee exportersand the Ministry of Trade have supported l
keeping this system on the basis that it prevents "unhealthy"
I competition,and that it provides securityfor exporters. I
| 5. The system of appointingapprovedexportersand the past l
allocationof quotas has severaldrawbacks. The opaque way by which
quotas were allocated created the opportunityfor abuse and apparently l
all6wed certain groups to maintain their quota rights (and hence quota
rents) without having much direct involvementin coffee. The security l
provided to current quota holders diminishedperformanceincentives,
(e.g., to increasequality)as there was a low probabilitythat the
| quota would be withdrawn. The barriers to entry to trade in coffee have
reduced compatitionon the domesticmarket resulting in lower farm gate
prices. Lower prices have not encouragedfarmers to invest in quality l
| improvinggrowing or sorting techniques.
I I
I l
I l
2/ Minister of Trade Decree No. 265lKp/X/89 states that althoughquotas |
have been lifted one must still be a registeredcoffee exporterto
be allowed to export.

l l
l l
l l
I l
l l
I I
I .I
I
I
 - 102 -

BOX 4.2
l l
| TEE MARKETINGOF NUTMEG
l l
1.
| Indonesia dominatesthe world market for nutmeg, supplyingover
| 70Z of the world's trade volume. The only alternativemajor source of
| supply is Grenada. Over 90Z of Indonesia'snutmeg is grown by
smallholderswho sell it through districtbuyers to provinciallevel
wholesalers. Exports are restrictedto approvied
exporters,who must be
| members of the Nutmeg Trade Association (ASPIN). Nutmeg was the last l
| major spice moved in to the approvedexporter list (afterpepper and l
j cinnamon),and there are now about 43 approved exporters. A Joint l
Marketing Board (JM0) was also created in 1986, at the same time as the
I product became restrictedto approvedexproters. The objectiveof these
regulationsis to prevent "unhealthy*competitionand thereby secure the
j highest possible price for Indonesia'snutmeg exports.
i I
I 2. Between 1986 and early 1989 ASPIN entered an agreementto sell |
j all of Indonesia'snutmeg through a single foreignspice trading firm at |
j an agreed price. With the implicitcooperationof the GrenadanNutmeg |
| Association,this firm was able to restrictsupply and increaseworld
I prices. However, as there was no official overall quota, approved |
| Indonesianexporters increasedtheir demand for nutmeg, causing domestic
| prices to increasefrom about Rp. 2,000 per kg in 1986 to Rp. 4,000 per l
| kg in 1988. In responseto these higher prices, the domesticoutput of l
| nutmeg expanded. In order to maintainhigh world prices the foreign l
| spice trading firm refused to purchase the increasedvolume of nutmeg,
| which encouragedapprovedexportersto find alternativebuyers. As a
| result the agreementcollapsed in early 1989, with the control of l
| exports revertingto the JM0. The JM0 attemptedto defend current l
| prices by posting a monthly price which all ASPIN members were to adhere |
l l
* I I~~~~~~~~~~~~~~~~~~~
 - 103 _

I~~~~ I

I I
I I
|to or face expluuionfromthe tradeassociation.As thispriceis high
in relationto currentworlddemandand supplyconditions,ASPINmembers |
|havebeen forcedto hold stocksor selloutsidethe agreement.Thishas |
|resultedin domesticfarmgatepricesfallingdrasticallyto Rp. 1,500
|perkg, which is belowthe worldprice. Domesticpricesare beingheld
|lowto allowapprovedexportersto sell-offlocalstocks.I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
I I
! I
 - 104 -

I .I
l l
BOX 4.3
l l
LONGERTERMEFFTCTS OF EXPORTRESTRICTIONSON
l l
| AGRICULTURAL
COMMODITIES l
l l
Cocoa and Palm Oil l
l l
1. In the early 19609 two African countriessuppliednearly 602 of
| the world cocoa and palm oil markets. During the next twenty years,
l l
Table l PERFORMANCE
OF COCOAANDPALMOIL EXPORTSUNDERALTERNATImV
I I EXPORTTAX REGIMES |
~~~~~~~~~~~~~
I I
Commodity and Export Export Growth Rate 1961-84
C mmodity and Export Market Share (S p.a.)
I
j Country Tax /a 1961-63 1982-84 Output Exports |
1. 1
| Cocoa l
Ghana High 40.1 14.4 -3.7 -4.2
Nigeria High 18.0 11.2 -2.0 -1.9 I
| Cote d'Ivoire Low 9.3 26.3 7.3 6.0 l

Palm oil
| Nigeria High 23.3 0.2 1.4 -23.6 l
Zaire High 25.1 0.1 -1.8 -15.5
Indonesia Moderate 18.4 8.2 9.7 6.2 I
| Malaysia Low 17.9 70.6 19.0 18.0 l
l l
/a The export tax includesboth the explicitexport tax plus an l
estimateof the overvaluationof the exchange rate. l

| Source: World DevelopmentReport, 1986. l

l l
l l
l l
I !
 - 105 -

I ~~~~~~~~~~~~~~~

these countries imposedhigh export taxes to exploit their perceived l

| monopoly positions.l/ These taxes seriouslyeroded domestic producer l
| profitability,resultingin lower levels of investmentand output l
| growth. Over the next twenty years their market share fell to 252 for l
cocoa and below 1X for palm oil (see Table 1). The constrastwith the
| performanceof Cote d'Ivoire (cocoa)and Malaysia (palm oil), over the l
same period is striking. Both countries avoidedhigh export taxes and
| both have achieveddramatic output growth, capturing growing shares of
the world market. Experiencefrom other countries (e.g., Argentina)
| indicates that it is easy to underestimatethe longer run effect that an
I export tax will have on relative incentivesand hence on domestic
| investment,efficiencyand competitiveness. This is particularlytrue
| for those commoditieswhere entry costs are not prohibitiveor where l
| close substitutesexist. l
I l
l l
l I
l l
ll
I I
|1/ These export taxes were imposedvia both crop specific taxes plus
the effects of misalignedexchangerates.

l I
i I
l l
I 1.
l l
l l
l l
l l
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I~~~~~~~~~ ..
 - 107 -

CHAPTE S

FOR FUTUREREFORM
A POLICY FRAMEWORK

A. The General Objectives of Reform

5.01 Since the mid-1980s,GOI has implementedseveral policy initiatives

intendedto create a more open and less regulatedtrade environment. These
reforms are part of an on-goingbroader deregulationprogram designedto
decentralizeeconomicdecision-makingand encourage greater participationby
the private sector. The guiding principlesof the trade reformshave been to
move towards a trade regime based on tariffs rather than restrictiveimport
licensesand to reduce the bias in incentivesagainst exports. While
significantprogress has been made, further steps are necessary to complete
the transitionaway from a 'high-cost'inward-orientedeconomy. As discussed
in Chapter 2, the net effect of the current trade regime is to impose a heavy
tax on trade. The continuingoverall anti-tradeor anti-exportbias can be
gauged by comparing the aggregateERPs for import-competing goods (+441)
against that for export-competinggoods (-21). The same bias applies across
sectors and within broad economicgroups. This pattern of incentiveshas
detrimentaleffects on economic growth and employmentcreation in
manufacturing(Chapter3) and agriculture(Chapter4).

5.02 The strong positive responseof the economy to the deregulation

measures taken to date, has created a favorableenvironmentwithin which to
pursue further reform. Private sector confidencein the government's
macroeconomicmanagement is strong and there are expectationsthat further
supportingmicroeconomicreformswill be forthcoming. This has resultedin-a
marked jump in planned foreign and domesticprivate sector investment. A
further reduction in both the level and variance of protectionis needed to
attract this investmenttowards activitieswhere Indonesiahas a clear
comparativeadvantage. This will encouragethe efficientallocationof scarce
investmentresourcesand avoid protectionistpressuresbuilding-upin the
future.

5.03 Following the rapid growth of non-oil exports during 1986-89,some

slowdown in growth rates may be inevitable. This is not surprisingas
existingcapacitybecomes more of a binding constraint. But this underscores
the importanceof a sound incentiveand regulatoryframeworkto achieve the
next stage of expansionof non-oil exports. Of particularconcern is the
recent slight appreciationof the real exchangerate and, more importantly,
the continuedanti-exportbias of the trade regime. There is also some
concern that the complex domestic regulatoryframework (includingthe legal
system) is slowing the pace at which planned investmentis being realized.1/
While Indonesia is now seen as a new low-costAsian export base, further
policy reform will be needed to take full advantageof this opportunity. The

1/ See Chapter I, for discussionof recent trends in approved and realized

investment.
 - 108 -

current robust macroeconomicconditionswould argue for acceleratingthe pace

of reform to capitalizeon this opportunity.

5.04 The broad objectivesunderlyingthe next phase of reform should be to

move towards a more neutral and administratively simple trade regime. This
implies that there should be fewer trade policy interventions(e.g., a
reduction in restrictiveimport licensesand export regulations)and that the
bias in favor of producing for either the domesticmarket or the export market
should be reduced. It also implies that where trade policy interventionsare
considerednecessary,e.g., externallyimposed quotas, the administrative
implementationmechanism should be transparentand efficient. More
specifically,the next phase of reform should includes

o Reducing the coverageof NTBs from the current level of 292 of total
domestic production,focussingon areas in both the manufacturingand
agriculturalsector where NTBs provide high protectionto domestic
production.

o Initiatinga medium-termtariff reform program by eliminating

split-tariffpositions,phasing out surcharges,and announcinga
phased plan to lower the maximum tariff rate from 60? to 202 over a
specifiedtime period.

o Reviewing the economiccosts and benefits of the current mix of

export regulations(particularlyexport bans, quotas and approved
exporter arrangements)to reduce export restrictionsand, where such
restrictionsare justified,to improvethe implementationmechanisms.

O Improvingthe efficiencyand coverageof BAPEKSTAand the export

credit/insurance mechanism,as part of a generalmove towards placing
all export assistancemeasures on a more commercialbasis - including
the removal of interestrate subsidies.

o StrengtheningGOI's institutionalcapacityfor analyzing trade policy

issues.

5.05 In terms of the timing and sequencingof the reform program, the
removal of as many import NTBs as possible remains the first priority. It is
recommendedhere that the removalof these NTBs be accompaniedby the initial
phase of tariff reform and, if possible, the removalof those export
restrictionsthat are clearlynot in the economy'sbest medium-term interests.
Based on experiencein other countriesit is also recommendedthat the tariff
rationalizationprogram be completedover a period of about three years.
Other componentsof the trade reform program, such as developinga stronger
institutionalcapacity for dealingwith trade issues, improvingBAPEKSTA,
reviewing the remainingexport regulations,and phasing out export finance
subsidiescould also be completedwithin three years. While domestic
political,economicand social factorswill determinethe actual pace of
reforms, studies of other countries indicatethat this sequencingof reform
steps is likely to achieve the strongesteconomicresults. These studies also
 - 109 -

indicatethat it is importantfor governmentsto give the businesscommunity a

clear signal of the directionof future policy change and to take steps to
convince the private sector that the reform programwill be implemented.
GOI's strong track-recordfor promptly implementingdifficultpolicy actions
has enhanced the Government'scredibilityand therefore its ability to
influenceprivate sector expectations.

5.06 Before discussingthe recommendedreform proposals in more detail,

two further points should be made. First, further trade reform needs to be
implementedwithin a balancedmacroeconomicpolicy frameworkwhich takes into
account adjustmentsin the trade regime. For example,the removal of most of
the remainingNTBs coupled with a significantloweringof the import tariff
will exert pressure£on the externalaccount. The economic repercussionsof
this type of microeconomicreform may need to be accompaniedby appropriate
macroeconomicmeAsures. As noted in Chapter 1, the consistencyof GOI's
monetary, fiscal and exchangerate policy has been a central feature of
Indonesia'ssuccessfuleconomicadjustmentto the severe external shocks
experiencedsince the early 1980s. With the immediateeconomiccrisis passed,
however, it is no less importantto continueto use these macroeconomic
measures to maintain externaland internalbalance. Second, to benefit fully
from the proposed trade reforws,complementaryaction in other areas, such as
the domestic regulatoryframeworkand the legal system,will be required.
There is some feeling in the businesscommunitythat reforms in the financial
sector and to some extent import regulationshave been implementedat a faster
pace than in other areas. Particularconcern has been expressedabout the
regulatoryenvironmentfor investmentsoutside of Jakarta. A concertedeffort
will be needed to maintain relativeprogress in deregulatingboth domestic and
foreign trade regulations,includingissues of implementationin the
provinces.

B. Ron-TariffBarriers to Imports

5.07 As part of the overall strategyto move to a trade regime based on

tariff rather than import licenseprotection,GOI intends to eliminateall
non-tariffbarrierson imports except for a small group of products that are
harmful to health, strategicto national defense or involve special economic
and social considerations.2/The Government'scommitmentto attainingthis
objectivehas been demonstratedby the four trade deregulationpackagesthat
have been implementedsince 1986. Nevertheless,over 900 items remain on the
RestrictedGoods List and, as discussedin Chapters 2 through 4, the resulting
NTBs are the primary cause of importantprice distortionsin manufacturingand
agriculture. These price distortionshave drawn resources into activitiesin
which Indonesiadoes not have a comparativeaao-vntage(e.g., sugar or motor
car production),increasedcosts for downstreamindustries,and lowered the
rate of economicgrowth and employmentcreationat the economy-widelevel.

2/ Government's"Statementon Economic Policy",Annex IV; Trade Policy

AdjustmentLoan II.

.
 - 110 -

5.08 The reductionof NTBs can be approachedin two ways. Either the NTB
on a particularproduct can be removed or the restrictivenessof a license
category can be reduced. The previousderegulationpackageshave used both
approaches,with an emphasis,quite correctly,on the former. Removing items
from the RestrictedGoods List (i.e., classifyinga good as IU) is
administrativelysimple and, more importantly,it unambigiouslyopens access
to all bona fide importers.3/ An importantobjectiveof Indonesia'sbroader
deregulationdrive is to simplifyand streamlineadministrativeprocedures so
as to encourageprivate sector initiativeand reduce the burden on Government
departments. The reclassification of productsunder the General Importer (IU)
license fulfillsthese objectives,and should remain the preferred option.

5.09 Where this has not been possible, or as an initial step towards
deregulation,productshave been moved from highly restrictivelicense
categories (i.e., PI or IT) to less restrictivelicense categories (i.e., IP),
and in some cases productshave been classifiedunder more than one license
category (e.g., IP/IT). One extensionof this approachwould be to reduce the
number of restrictivelicense categories. For example,the 348 products that
are classifiedas IT (i.e., restrictedto the six State Trading Corporations)
could automaticallybe classifiedas IP items (i.e.,open to all importer-
producers). This would reduce the number of license types (by merging the IT
license categorywith the IP license),and significantlyincreasecompetition
by broadeningaccess to all importer-producers.While such a move would be
desirable,it does not completelyremove the necessityto gain administrative
approval to import a restrictedcommodity - i.e. one would still need an IPIIT
license. Hence, the strong preferencefor reducingthe number of goods on the
RestrictedGoods List by reclassifyinggoods under the IU license.

5.10 Partly because of the scope of the previousderegulationpackages,

the next phase of removingimport license restrictionswill entail focusingon
difficultareas. The reductionof the coverageof NTBs below the current
level of about a third of total domestic sales will involve: (i) the removal
of all remainingNTBs in industriesthat have already been subject to
deregulation(e.g., steel, textiles,chemicals,paper and pharmaceuticals);
(ii) reducingthe tradingmonopoliesthat BULOG and the STCs have on
agriculturalcommoditiesand processed food and beverages;4/and (iii)
dismantlingthe currentmix of import license restrictions,import bans and
domestic regulationsthat are used to protect the local mechanicaland
electronicgoods industry,includingheavy equipmentand motor cars.

3/ For detaileddefinitionof the various import license types see

Chapter 2. Briefly,the IU license is non-restrictive,requiringonly
a businesspermit and a tax payers number. All other license
categories(i.e., IP, AT, IT and PI) are restrictiveto various
degrees.

41 Where strategicor special economic/socialconditionsare paramount,

these should be clearly specifiedtogetherwith the rationalefor
restrictinginternationaltrade to one trader.
 - ll -

5.11 As discussed in Chapter 3, the remainingNTBs on steel, textiles.

chemicals,paper and pharmaceuticalsare on particularproductswhere concerns
for existingmanufacturingplants have slowed the pace of reform. Failure to
tackle these difficultareas will, however, retard the restructuringof these
industries,and have broader detrimentaleffects through the negative price
effects on downstreamusers. In most cases the process of restructuringthese
industriesis already underway,and the move to an import tariff of 202 or 302
would not cause major dislocations.

5.12 In the case of steel, the domesticindustry is competitivein basic

steel products (slabs and billets) and hot rolled steel products. This part
of the industrycould be completelyderegulatedand placed on a tariff of less
than 202. Productionof tin plate, cold rolled steel and the associated
downstreamproducts (e.g., tin cans or galvanizedsteel sheets) is less
efficient. Both the tin plate factory and the Cold RollingMill are high cost
producers,partly due to low volume throughputand/or high outstandingdebt
repayments. Given the sensitivityof the issues involvedin exposingthese
plants to open competition,some form of direct measures to permit both these
factoriesto sell close to world prices would be desirable. Containingthe
deviationfrom world prices at the plant level would at least reduce the
detrimentalprice effects on potentiallycompetitivedownstreamactivities
(e.g., processed food producersusing tin cans) capital goods manufacturers
and the constructionindustry.

5.13 The removal of the remainingNTBs in the textilesindustry involves

two distinctissues. First, there are a number of synthetic fibres and yarns
that continue to be categorizedunder the IP license. While this does not
appear to be hampering the current developmentof the industry,it has raised
concernsin the minds of downstreamfabric and garmentmanufacturersabout the
directionof future policy. Given the importanceof the textile industryto
non-oil export earningsand employmentin the manufacturingsector, the
competitivenessof the more labor-intensive downstreamindustryshould not be
compromisedby increasedprotectionof the capital-intensiveupstream
industry. The removal of the remainingNTBs on syntheticfibres and yarns
would reaffirm the government'scommitmentto maintaininga competitive
textilesindustry. Second, there are about 250 split-tariffpositions in the
textilessector whichhave been created to cover all batik fabrics and
garments. These items have been restrictedto the State Trading Companies
(STCs),and placed under an informalban. This reflectsGOI's efforts to
protect a part of the indigenousbatik industrywhich is extremely labor
intensiveand is consideredto warrant protectionfor economic and cultural
reasons. The RestrictedGoods List could be greatly simplifiedby removing
these split-tariffpositionsand making the specialprovisionscurrentlybeing
made for the batik industryexplicit. This could be achievedeither through
an above average tariff or a formal ban.

5.14 The NTBs on chemicals,pharmaceuticalsand paper cover a wide range

of products. With the exceptionof whitenewsprintpaper, none of the
restricteditems account for a significantshare of domestic output in these
 - 112 -

industries. For the most part, further reform would involve a 'cleaning-up'
exerciseto remove the remaininganomalieswithin industrieswhich have been
largely deregulated. This would encourage further restructuring,reduce the
profits of some traders,and yield importantbenefits to downstreamusers -
includingdomesticconsumers.

5.15 The extensivecoverageof import license restrictionson processed

food and beveragesand agriculturalcommoditiesis discussed in Chapter 4.
Most of the processed food and beverage items are restrictedto the State
Trading Companies (STCs),particularlyTjipta Niaga and Kerta Niaga. The
recent growth in processed food exports and the declining share of the STC's
businessthat is derived from this import/exporttrade, indicates that both
STCs and domesticprocessed food producersare well positionedto adjust to a
more competitivepositionunder tariff protection. A recent survey of STCs
indicatedthat over 702 of their businessis derived from the domestic
distributionof goods. Trading in imports accounts for less than 252 of their
turnoverand has been declining since 1986.5/ Moreover, removingthe monopoly
trading rights of STCs will not necessarilyresult in a loss of business.
Where STC do have a competitiveedge, they should retain a major share of the
import trade. With regard to the domesticprocessed food industry,it would
appear that most firms could compete against importswith moderate to low
import tariff protection. This is illustratedby the rapid growth in
processed food exports (albeitfrom a small base) from firms that have access
to inputs at world prices.6/ Nevertheless,producers for the domesticmarket
are disadvantagedby having to purchasesome importantinputs at prices higher
than world prices - particularlypacking materials (tin cans and tetrapak)and
sugar. Consequently,the removalof NTBs on procassed food and beverage
products should be accompaniedby the simultaneousremoval of all NTBs on
upstream inputs into the industry.

5.16 The NTBs on agriculturalcommoditiesrestrictedto BULOG (primarily

rice, wheat, wheat flour, sugar, soybeansand soybean meal) cover a large
share of agriculturalvalue added and trade. With the possible exceptionof
rice, the resultingprice distortionshave encouragedagriculturalresources
to be used in activitieswhich yield low economic rates of return and have
taxed Indonesianconsumers (see Chapter 4). Given the importantrole that
these crops play in the agriculturalsector, changes in trade policy will have
to be assessedin the context of GOI's overall agriculturalstrategy.
Nevertheless,these crops are also importantto the majority of Indonesian
consumers. In the case of rice and wheat, some easing of BULOG's monopoly
positionmay be warranted to increasecompetitivepressures on both traders
and producers. As a first step, a quota allocationfor each product could be
auctionedoff to private traders. This would reestablisha more direct link
between domestic and world prices and provide a useful safety-valuewhen
domesticproductionfalls below expectations(e.g., the rice crop in 1987/88).
If successful,the quota could be graduallyincreased,until such a time as

5/ Exports account for the remaining52, primarilycoffee and spices.

6/ See Chapter 4, Case Study of ProcessedFood Producers.

 - 113 -

moving to an import duty is consideredappropriate. BULOG could still play

its role in stabilizingdomesticprices, by purchasingor selling these
agriculturalcommoditiesto moderatethe impact of private market
rransactions. The trade restrictionson sugar and soybean meal could be
removed immediatelyand replacedwith an average tariff.

5.17 Removing the NTBs on mechanicaland electronicgoods involvescomplex

issues related to GOI's broad industrialsector strategy. As discussed in
Chapter 2, trade barriers (bans,AT and IP licences)and the domestic
content/deletionprogram are used to encouragethe developmentof an
indigenousengineeringcapacity. Currently,the engineeringsector is
encouragedto produce a wide range of mechanical,electricaland transport
equipment. While Indonesia'scompetitivenessin this area is improving,there
are a number of productswhich can only be produced at very high cost - in
some instancesat negativevalue added in terms of world prices. For example,
recent price comparisonsfor AC generators(CBU), TV sets, and motor vehicles
revealed Indonesianprices to be 922, 272 and 422 above the respectiveworld
price. The resultinghigh cost of capital goods imposes additionalcosts on a
wide range of domesticdownstreamindustries- some of which are, or could be,
competitiveon world markets.

5.18 In recognitionof this problem, the Governmentallows export-oriented

firms to import some of their capital goods duty free, through either BKPM or
BAPEKSTA. While this is a useful mechanism for exporters,it does not assist
producers for the domesticmarket or small-scaleexports,and approvalto
import duty-free is still subject to administrativediscretion. In addition,
efficientdomesticproducers of mechanicaland electronicequipmentcan be
disadvantagedby the current system. For example, if an investmentproject
has BKPMIBAPEKSTAapproval,domesticsuppliersof engineeringgoods to this
project ha'e to compete against importedmachinerywhich is exempt from import
duty prote:tion. This may disadvantagedomesticproducerswhere they have to
purchase some of their inputs (e.g., steel or tin) at above world prices from
domestic suppliers.

5.19 Moving away from the current complex administrativesystem for

miechanicaland electronicalgoods towards fairly uniform tariff protection
would have several advantages. These include: (i) the engineeringsector
(definedin its broadest sense) would be encouragedto rationalizedomestic
production,focusingon those productswhich can be produceddomesticallywith
moderate tariff protection; (ii) the degree of administrativediscretion
involved in determiningaccess to these goods at world prices would be
removed,creating greater certaintyfor downstreamusers (especiallyfor small
and medium size enterprises);(iii) the differentialaccess of export-oriented
as oppose to import-substitution activitiesto capital goods would be removed;
and (iv) the tariff structurewould still permit slightlyhigher tariffs to be
levied on those mechanicaland electronicproductswhere GOI decides it is
importantto encouragedomesticproduction.
 - 114 -

C. Tariff Refonm

5.20 IL has been five years since the last major reform of Indonesia's
taviff schedule. Since that time, the substantialprogressmade in reducing
NTBs has, as intended,increasedthe relativeimportanceof tariffs in the
incentiveregime. At the same time, partly in responseto the removal of
NTBs, ad hoc changes have been introducedin the tariff structurewhich have
increasedthe level and dispersionof tariffs,particularlyin the
manufacturingsector. While the detrimentaleffect that the resulting import
tariff schedulehas had on exports has been partiallyoffset by an efficient
import duty exemption scheme (BAPEKSTA),this facilityhas been less
successfulin reaching small-scaleor indirectexporters. Moreover, BAPEKSTA
cannot assist disadvantagedproducers for the domesticmarket or Indonesian
consumers. Given the anticipatedremoval of more NTBs and the recent increase
in private investment,it is opportune to considera systematicreform of the F
current tariff schedule.

5.21 There is a substantialamount of empiricalevidencewhich suggests

that the primary objectiveof tariff r.form should be to move towards a tariff
structurewhere both the absolutelevel and the variance between tariff rates
is as low as possible.7/ Such a structurereduces the range of protection
provided to differenteconomicactivities,lowers the tax on domestic
consumers,and removes the pressures to provide special treatmentto powerful
lobby groups. Moreover, the design of an optimum tariff structure requires
detailed informationon a wide range of constantlychangingprices and
productiontechniques,which policy-makersin any country are unlikely to
have. While the theoreticalconditionsfor ensuringthat a low single uniform
tariff structureis optimum will seldom be satisfied,the costs of deviating
too widely from this bench-markmay be very high.

5.22 For these reasons,the tariff reform program discussedbelow has been
designed to move towards a low and fairly uniform structureof statutory
tariff rates. The proposedprogram has two basic components. The first
involvesa 'tidyingup, of the current schedulethrough the removal of split-
tariff positionsand the gradual eliminationof surcharges.8/ The second is
a broad-basedstrategyinvolvingthe reductionof both average tariff rates
and the degree of tariff dispersion. The broad-basedreform is based on
tariff reductionsacross the whole tariff structureas opposed to reductions
in tariffs for particularindustries. The industry-by-industry approach is
not recommendedbecause it can open the tariff reform process to protracted
negotiationswith affectedgroups, and it can result in a temporaryworsening -
of price distortionsdue to complex inter-industrylinkages. Reducing tariffs
across the tariff structureis preferablebecause it appears even-handed,it H

7/ See "Trade LiberalizationtThe Lessons of Experience",by Michaely,

Choksi and Papageorgiou;and 'StrengtheningTrade Policy Reform",World
Bank; and "Issuesin the Design of Tariff Reform" by Prof. A.C.
Harberger.

8/ For definitionof split-tariffpositions,see Chapter 2.

 - 115 -

removes the discretionaryelement in decidingwhich industriesto rocus on

first, and it is administrativelysimple. Finally,establishinga lower more
uniform import tariff would also relieve the administrativepressure currently
placed on BAPEKSTA. As non-oil exports expand further,the burden on BAPEKSTA
to efficientlyprocess a greaternumber of applicationswill grow. Lower
tariffswould reduce the incentivesto use BAPEKSTA, freeingBAPEKSTA'sstaff
resourcesto extend the scheme to capture small-scaleand indirectexporters.

5.23 Split Tariffs. As discussed in Chapter 2, the subdivisionof the

tariff code by the use of splits complicatesthe tariff schedule in several
ways. First, there is a loss in transparencywhen the split-tariffposition
is used to provide NTB protection,or differentialtariff rates, to part of a
standard9-digit product description. As separatetrade data are not
collected for split items, policy makers cannot assess the implicationsof the
increasedprotection. Second, the use of splits increasesuncertaintybecause
they can be created and changedmore easily than the basic tariff code.
Finally, they can be used to provide "made to measure" assistancefor very
specificproducts,which runs counter to the Government'sobjective of
establishinga more uniform tariff structure.

5.24 The removal of splits should be accomplishedby absorbingthe split-

tariff positionback into the base-tariffposition. The tariff and surcharge
rates applied to the single item could then be set at either the rate that
applied to the old split item or the rate that applied to the old base item.
Given the general rationaleof the reform effort there would be a strong case
for selectingwhatever import duty rate was lower.91 The removal of splits
will result in a reductionof the dispersionof tariff rates, both overall and
within commoditygroups. It will also eliminatethe unequal treatmentgiven
to particularcommoditieswithin commoditygroups and hence the uncertainty
this generates.10/Column one of Table 5.1 shows the effects of removing
splits and applyingthe split tariff rate to the unified item.

5.25 Surcharges. The use of surchargesentails many of the same drawbacks

associatedwith splits. They can be imposedmore easily than the basic
statutorytariff can be changed,and they can be used to target assistanceto
specificproducers. It is proposed that all surchargesbe removed in a
phased, systematicmanner. First, as there remains some uncertaintyabout the
extent of suroharges- which surchargeshave lapsed and so on - it would be

91 As uoted in Chapter 2, split tariff rates are on average lower than

base tariff rates while split surchargerates are on average higher.
Thus, it may be appropriateto adopt the split tariff rates and the
base surcharge rateswhen removingthe splits. This is not a crucial
point however as in aggregate,unweightedterms the differenceis
minimal.

101 If there are truly compellingreasons for separatelyidentifyingsplit

items, then as a minimum these items should be given their own code
within the HarmonizedSystem. This is an inferioroption to the
removal of splits but will at least ensure that separatedata are
collected for the split item.
 - 116 -

useful to issue a complete list of which surchargesare currently in effect.

In compiling such a list, it may be appropriateto conduct a broad-based
review, removingsurchargeswhere they are no longer necessary. Second, as
many surchargeswere introducedto provide temporaryprotectionfollowingthe
removal of NTBs, it should be announcedthat all surchargesare to apply for a
period of one year. After that year, extensionswould be granted only to
those activitieswhich are restructuringto become more efficientand
competitive. The remainingsurchargewould have a maximum value of 502 of the
originalrate and would apply for one year. After the second year, all
surchargeswould automaticallyexpire,with no exceptions.

5.26 If, after the initial publicationof the full surchargelist it is

deemed necessary to provide temporary surchargesfor additionalitems,ll/ it
should be clear that these surchargesare subject to the same "sun-set'
clause. Thus, the additionalsurchargeswould be reviewedafter one year.
Those that are not removedduring the review period would be set at half the
originalrate and then revert to zero after one furtheryear. Proceedingin
this manner places a definiteend-pointto the use of surchargesand avoids
any item receiving special,ad hoc treatment. The phasing of the removal of
surchargeswill allow those industriesmoved off NTB protectiontime to
adjust. The impact of removingsurchargeson Governmenttax revenue is
minimal, estimatedat less than 0.1? of total non-oil tax revenue.12/

5.27 As mentioned in Chapter 2, an additionalreason for the introduction

of surchargeshas been a defense against dumping. Surcharges,however, do not
constitutean appropriateanti-dumpingdevice. Surchargesapply to particular
commoditiesover a period of time whereas anti-dumpingproceduresconstitute
essentiallylegal actions by one party (for example, a firm) against another
with respect to a particularshipment. Thus, the appropriateresponseto
dumping is the impositionof specificpenaltiesrelated to a particular
supplierrather than measureswhich apply to a broad commoditygroup. If
dumping is indeed a significantproblem within certain industries,then the
appropriateresponseis to establishanti-dumpingprocedure alignedwith GATT
rules.13/ This would involve the clear demonstrationthat dumping has
occurred and has in fact damaged particular firms. Clear procedures would
eliminate the possibilityof the benefitsof the reform being reduced as has
been evidenced in the past use of surcharges.

11/ For example, followingthe remo7al of NTB protection.

12/ The revenue implicationsof both the removal of surchargesand the

reduction in base tariff rates is discussedin more detail in paras
5.37 to 5.40 below.

13/ GATT principlesrequire that duties only be imposed to the extent of

any dumpingmargin and that they only be imposed once it has been
establishedthaes: (a) dumpinghas occurred; (b) injury has been caused
or threatenedto a domesticindustry;and (c) there is a causal link
between dumping and injury.

I
 - 117 -

Tgble6.1: rECTSOF PR S o PROOW ON UNiHT

AVERAGE
TMIFF

Socor Removal Reduction

in TariffCeilIng
of SpiIts 50 80 20

Econog-wlid 26 28 18 14
Agriculture 16 16 16 12
Mining 6 6 6 S
Manufacturing 27 24 19 14
Mnufaeturinasector
FoodManufacturing 27 26 23 17
Boverges 41 41 27 19
Tobacco 52 25 26 17
and Tobacco
Food,Beverages 26 27 24 17
Textiles 44 89 26 18
Wearing apparel s6 46 29 20
Leatherproducts 24 24 17 18
Foctwear 70 48 8o 20
Textilee, leather and footwear 48 40 26 19
Wood,cork and products 25 26 26 18
Woodfurniture 47 47 30 20
Wood,cork and product. 29 29 28 18
Paper produet 21 21 21 1S
Printing and publishing 18 18 16 11
Paperand printing 21 21 20 14
Industrial chemicals 8 8 8 7
Otherchemicals 16 16 1S 12
Petroleumrefining 6 t 5 6
Petroland coalproduct. 6 6 6 6
Rubberproducts 42 25 18 14
Plastic products nec 87 87 27 19
Chemical, petrol and coal 14 18 12 9
Ceramic products 52 44 27 18
Glass and glass products 87 84 22 16
Other non-met l pr,duct. 29 27 20 15
Non-metallic Industries 86 82 22 16
Iron and steel basic metal produ-'e 10 10 10 8
Non-ferrous basicetal prod :b 10 10 10 9
Basic metal products 10 10 10 8
Metal products nec. 26 24 22 17
Non-electric machinery 14 14 18 11
Eloctric machine-y 28 22 18 1i
Transport equipment 87 23 16 11
Scientific equipwnt 15 14 14 12
Metalproduct. and machinery 21 19 16 18
Other manufacturing 86 s6 26 18
Dispersion 89 77 64 66

Source: World Bank staff estimates.

 - 118 -

5.28 Broad-BasedReform. The above proposalsessentiallyset the stage

for a much broader-basedreform of the tariff schedule. The proposal here is
to reduced the highest allowed tariff rates to a common ceiling,and then to
lower the ceiling tariff over time. This 'tops down' approach results in a
reduction in the level and variance of protectionat each step. The exact
ceiling rates and the phases should be carefullychosen and clearly announced
at the outset of the reform program. Such preannouncementsends a clear
signal to the businesscommunityconcerningthe directionof future policy
change which reduces investoruncertaintyand enables more informed investment
decisions to be made.

5.29 The proposalexplored in this report is to move to a 50X ceiling in

year one, 302 in year two and 20? in year three. To establish the credibility
of the program, the plan to introducea phased reductionin maximum tariffs
could be announced at the same time as the 50? ceiling is imposed and measures
are taken to deal with splits and surcharges. In addition,it may be
worthwhileconsideringrationalizingthe tariff structurefurther by imposing
more uniform rates within commoditygroups. This would result in some low
rates (zero or 5? import duties) being raised. Finally,it would also be
desirable to eliminate some of the exemptionsto import duty, replacingthem,
where appropriate,with less distortionarycorporateor investmenttax
credits.

5.30 The overall approachhas the practicaladvantageof being simple,

easy to administer,and would involve a minimum of uncertainty. The timetable
would be announced in advance and details of all the items affectedat each
step of the reform could be provided. Thus firms would know the pace at which
protectionfor their productswill diminishwhich should reduce the costs of
adjustment.There is also flexibilityin the detaileddesign of the reform
program -- the timetable,the tariff rates that are chosen, etc.
Nevertheless,given the likely resistanceto change from powerful vested
interests,there is a strong argumentto implementthe reform in a relatively
short period - particularlyif this can coincidewith a period of
macroeconomicstabilityand robust growth. In addition,the recent
significantjump in actual and planned private investment,underlinesthe
necessityof creatingan incentiveframeworkwhich channelsnew resourcesinto
competitiveactivities.

5.31 Step 1: Tops down to 50 per cent: There are some 1500 items *iith
tariff rates above 50 per cent in the Indonesianschedule. Those with the
highest rates are motor vehicles and tires. Tires are protectedby
specific-importduties, the ad valorem equivalentof which are very high in
many cases. Reformingthese items will involve changingthe tariff from a
specificto ad valorem and adoptinga maximum import duty rate in line with
other tires (20? to 40?).

5.32 The effect on average tariffs of tops down to 50 per cent is

presented in Table 5.1. Clearly,the greatestpressurewill be felt in
transportequipmentand rubber products and indeed there may be considerable
 -119-

resistanceto a reductionof these tariff rates. It should be ensured that

this does not prevent reductionsin other tariffs from taking place. If
necessary,the tariffs (and in some cases bans) on motor vehicles can be
maintainedas a special case. However, there would need to be very clearly
defined reasons for this. Further,it is likely that the objectivesbehind
the use of the tariff on motor vehiclescould be achievedmore efficiently
through other policy instruments,such as an excise or general luxury tax. If
it is decided to maintain the tariff, the conmunity should be aware of the
costs of doing so.

5.33 Step 2: Tops down to 30 per cent: From the tariff structure
establishedin step 1, reduce all tariffs above 30 per cent to 30 per cent.
Table 5.1 summarizesthe effects of this. In terms of average tariff
reductions,the greatestchanges occur within textiles,leather and footwear
and within non-metallicindustries. In particular,wearing apparel, footwear
and ceramic productsexperiencelarge reductionsin average tariffs. This is
unlikely to cause major problemsas most of these industriesare now primarily
geared to the export market and could compete on the domesticmarket with
significantlylower import duties.

5.34 Step 3: Tops down to 20: From the tariff structureestablishedin

step 2, reduce all tariffs above 20 per cent to 20 per cent. Table 5.1
summarizesthe effects of this step.

5.35 RationalizingTariff Rates: The above changeswill result in a

reductionof average tariff rates as well as a substantialreductionin
dispersion. As noted above, the tariff schedulecan be further rationalized
by ensuring that broad commoditygroups, at the 4-digit level for example,
receive uniform tariff rates and by removingsome tariff exemptions. Actual
import tariff collectionsare less than half the current average statutory
tariff rate, reflectingthe effect of numerous tariff exemptions. In the case
of BAPEKSTA, the import duty exemption is justified. However, the need for
import duty exemptionsfor general investmentshould be reconsidered,as
should exemptionsfor the oil and gas industry,importedinputs for specific
traders (e.g., edible oil), and foreign aided projects. In some instances,
this will involve the raising of tariff rates. This will ensure a more
uniform treatment for particularproducts,and will raise additionalrevenue.

5.36 Other Componentsof Reform: As mentioned above, it is importantthat

the reform be announced in advance with a clear timetableand that this
timetable is adhered to. This will increasethe creditibilityof the reform
program and considerablyaid adjustmentto the new tariff regime. It is also
importantthat the governmentbe informedas to how the reform is proceeding
and monitor its effects. This is a fairly data intensive,complex task, which
would be best undertakenby a unit specificallyequipped (both in terms of
hardware and expertise)to analyze and examine tariff reform in an economy-
wide context. Such a unit would provide quantitativeinformationand analysis
to the governmentconcerningthe effects of reform and deal with the
inevitablelobbyingfor exceptions.
 - 120 -

5.37 As tariff policy is only one element of a countrv'soverall economic

strategy,it is importantto ensure that tariff reform proceeds in a manner
consistentwith general economicpolicy. For example, there are close links
between tariff policy and domestictaxationpolicy as well as between tariff
policy and investmentpolicy. The analyticalunit suggestedin the preceeding
paragraph should also have the capabilityto assess the interactionbetween
these policies.

5.38 Revenue Effects of ProposedReforms. In many countries,tariffs form

a large share of governmentrevenue. Thus, the revenue effects of tariff
reform are of major concern. In Indonesia,the share of import duties in
total governmentrevenuehas declinedsince the late 19709, and is niw at
around 4 per cent. At the same time, broad tax reform has increasedthe
importanceof other forms of revenue,such as consumptiontaxes (Graph 5.1).
Even without further tariff reform, import duties are taking a lower profile.
Indeed, Indonesia appears to have considerablescope for replacingany lost
tariff revenue with revenue from less distortionarytaxes. In examining the
revenue effects of tariff reform, it is importantto considerall forms of
governmentrevenue. As will be argued below, what revenue is lost as tariffs
are reduced is likely to be more than regainedas the benefits of reform, in
terms of increasedimports and a higher rate of economic growth, are felt. It
is also importantto note that the estimatesprovidedhere make no allowance
for the additionalimport duty revenue that could be generated from either
removingmost of the remainingNTBs or reducingthe number of import duty
exemption schemes.

5.39 Surchargesaccount for around 4 per cent of total revenue from import
duties or less than 0.lZ of total non-oil governmenttax revenue. Thus, with
no increase in imports followingthe removal of surcharges,tariff revenue
would decline by around 4 per cent. Accountingfor the change in demand for
imports,tariff revenue is estimatedto declineby 3 per cent - assumingthat
imports are fairly unresponsiveto price changes. As tariff revenue is around
4 per cent of total governmentrevenue,this amounts to a reduction in total
revenue of around 0.1 per cent.

5.40 Adopting the tops down tariff reformswill also lead to a reduction
in tariff revenue. Going tops down to 50 per cent could lead to a tariff
revenue reductionof 6 per cent - that is, a reductionin total revenue of 0.2
per cent. Proceedingwith the next step - from the new import base - could
lead to further tariff revenue reductionsof around 10 per cent - or 0.4 per
cent of total revenue. The entire tops down process, from beginning to end,
could lead to a reductionin tariff revenueof around 30 per cent. This is
equivalentto a reductionin total revenueof around 1.2 per cent. This
figure should be treatedwith some caution,however. It is calculatedby
assuming that tariff revenue is only influencedby changes in tariffs and
changes in import volumes inducedby import price changes. In reality,as
tariff reform proceeds, the level of importswill be determinedby a number of
other factors, such as changes in incomes. As incomes increase,so will
imports and, therefore,tariff revenue collections.

~~~~~~~~~~~~~~~~~~~~~I
 - 121 -

Graph 5.1: Share of consumptionandimporttam in total

govemmentrevenue

26-

Zo / \\ /

as

a.
6_
10

70 10 a 64 6s as
Year
a CoaaumpUo taexe * tipart taXme

Source: WorldBanikstaff estimates.

5.41 Introducing tariff reform will be beneficial to the economy, leading

to increased GDP and increased incomes. Such increases will lead to hig,!r
revenue collections from sources such as income and commodity taxes.
Indonesia's past experience indicates that collections from these sources are
proportional to GDP, so every percentage in GDP will lead to a similar
percentage increase in revenue collections. Thus, an increase in GDP of
around 2 per cent over the three year period of tariff reform would more than
offset the reductions in total revenue occurring as a result of lost tariff
revenue.

D. The Export Regime

5.42 Indonesia's export regime is comprised of two types of policy

interventions, export regulations (bans, quotas, taxes and approved exporter
arrangements), and export assistance measures (the import duty exemption
scheme and the subsidized export credit program). The significance of both
 - 122 -

these policy interventionshas increasedsince 1986. As discussed in

Chapter 2, the trend towards increasedexport regulationsis worrisome -
particularlywhere the policy instrumentscreate artificialbarriersto entry
and are non-transparent. These regulationsmay not be in Indonesia'sown best
interestsand even in those limited instanceswhere there is a case for
intervention,the current policy instrumentsmay not be appropriate. The
recent expansion in the use of BAPEKSTAand the export credit program reflects
the growing importanceof non-oil exports to Indonesia'seconomy. While the
BAPEKSTA scheme does provide a useful mechanism by which to circumventimport
barriers,more direct measures to reduce NTBs and import tariffs are
warranted. Moreover, the provisionof subsidizedcredit is not an appropriate
method by which to assist exporters.

Export Regulations

5.43 While the Government'sdesire to increasedomesticprocessingis

understandable,care needs to be taken in decidingon the appropriatepolicy
instrumentsthroughwhich to achieve this objective. In general, the
regulationsof exports can be justified on economic grounds only under very
specific (and rather uncommon) conditions. Factors such as the share of the
world market, the price elasticityof demand, the availabilityof substitute
productsand the supply conditionsin the export country,all need to be taken
into account. Experiencein other countrieswhich have imposedexport
barriers, provides strong evidencethat the dynamic effects of these
interventionsare often negative (see Box 3, Chapter 4). A thorougheconomic
analysis should, therefore,be done for each regulatedproduct,with the
burden of proof lying on the need for regulation. In addition,such an
analysiswould have to be repeatedperiodicallyas global demand and supply
conditionschange. Aside from whether a product should be regulated,a second
but no less important issue, concernshow a product is regulated. The
economiceffects of differentpolicy instruments(e.g., a tax as opposed to a
ban) vary significantlyin terms of efficiencyand the distributionof
benefits and losses.

5.44 The productswhich are subject to export regulationsin Indonesiacan

usefully be divided into three categories.

o those productswhich are subject to externally-imposed

trade barriers
(i.e., textiles,tapioca,and until recently,coffee);

o those productswhere Indonesiahas a large enough market share to

influenceworld prices (i.e., logs, plywood, raAtan,nutmeg and
rubber);and

o those productswhere Indonesiais largely a price taker.

5.45 Where externalbarriersexist, the key requirementis to create an

efficient and equitablequota allocationmechanism. Taking the example of
textiles there are two basic options. First, the Governmentcould try to
 - 123 -

improve the current system. This would involve steps to improve the
transparencyand efficiencyof the Government'squota allocationmechanism and
the operation of the quota exchangemarket. As a minimum the Ministry of
Trade should publish informationon quota holders (by detailedcommodity
groups and market), the export performanceof quota holders and production
capacity. If past performanceis the sole criteria,any quota expansion
should be awarded on a pro-ratabasis to exportersto non-MFA markets for the
most recent period. If other criteriaare used, and a non-price allocative
system is employed, these criteria should be defined as clearly as possible to
reduce administrativediscretion(i.e., 'newcomer'or 'weak economicgroup'
are difficultto put into operationalterms).

5.46 A second option would be to move to an open auction system. This

would have severalbenefits including;quick and relativelystraightforward
administrationof the quota allocations;ensuringthat quotas are allocatedto
exporterswho have an incentiveto maximize returns on quotas through full
utilizationof high value export items; discouraging'rent-seeking;and _
ensuring that the quota rents are appropriatedby the Governmentand can be
monitored. Finally, whatevermethod is used to allocatequotas, the existing
administrativecapacity to monitor quota utilizationfor each market and
product should be strengthened. These records should be consistentwith the
importingnations data to avoid the risk (as has happened in the past) of
violating quota agreements,and should be in the public domain. The quota
monitoringbody should also be used to negotiate internationalquota
arrangementsand lobby GATT for the removalof the MFA.

5.47 Whether the first or second option is adopted, it will be important

to create an open secondarymarket where quotas can be freely traded. The
current penalties imposedon those quota holders that use the quota exchange
encouragestrading to occur in an informalmarket which may not operate
efficiently. The removalof penalties for trading the quota will focus
attention on the rationaleunderlyingthe initial quota allocation. The
benefits of an open quota auctionwill be a more efficientallocationand use
of Indonesia'squota as well as a clearer indicationof the value of different
quotas - includingwho are the quota rent recipients.

5.48 Where Indonesiacan influencethe world market price, a theoretical

case for an optimal export tax exists. The primary issue here is to set the
tax at a level which maximizes the economy'sgains over the medium-term. In
practice, these taxes are difficult to estimateand, as discussed in
Chapter 4, while part of the costs of the tax will be passed on to foreign
consumersvia higher prices, part of the benefitsare also passed on to
foreign producers. Other producersof the same product (or a close
substitute)receive the higher world prices that the tax creates,without
incurringthe costs of the tax. This will encourageproducers in other
countries to increasetheir output at the same time as productionin Indonesia
is discouraged. As a result, the benefitsderived by the country imposingthe
tax may be short-lived- except where the costs of entry by foreign
competitorsare high. In addition,world demand will decline as a result of
the more efficientuse of the taxed commodityand a switch in consumptionto
substitutegoods.
 - 124 -

5.49 In the final analysis, the use of export restrictionsis an empirical

issue which should be analyzed at the commodity level. If it is decided to
impose an export restriction,there are strong reasons for choosing an export
tax rather than imposinga quota or ban.l41 As discussed in Chapter 2,
quotas and bans can create incentivesto engage in wasteful 'rent-seeking'
behavior and be used to restrictdomestic ompetition. This in turn lowers
the incentivefor innovationand improvementsin efficiencywhich would work
against Indonesia'slong-runcompetitiveness. Channelingexports through
domesticcartels--asis occurring for a number of agricultural
commodities--maybe particularlyharmful to domestic producerswho supply -
"approvedexporters",as well as running counter to GATT rules. -

5.50 As a first step towards reform the Governmentshould review the

currentmix of export regulationsand where possible replace quotas and bans
with an export tax. This approachwould mirror the reform program adopted by
the Governmentwith respect to import restrictions,where NTBs are being
replacedby import tariffs. In addition,the analyticalcapacity of
I
Governmentneeds to strengthened,to determinewhat type of export restriction
is optimum (i.e., the level of export tax). This will require an objective
governmentbody to monitor developmentsin int.rnationaland domesticmarkets,
and developmentof a capacity to use this infermatiorito demonstratethe
benefits or costs associatedwith the propos I trade restriction. If
possible,decisions to restrictor tax expotrs should be discussedby all
effectedparties in a public forum. One example of such an institutionis the
Australian IndustriesAssistanceCommission (IAC)which may provide some
useful institutionallessons.

5.51 Where Indonesiacannot influencethe world price, the case for any
type of export restrictionis weak. As discussed in Chapters2 and 4, export
restrictionson commoditiesin which Indonesia is a "price taker" are unlikely
to be in the country'sown best interests. The result is to lower returns in
activitiesin which Indonesiais competitive(e.g.,crude palm oil, crude
coconut oil and copra) in order to provide a subsidy to inefficientdownstream
processors (e.g., edible oil producers). This will lower investment/technical
change, and hence growth, in the taxed activity,as well as forsteringthe
developmentof an uncompetitivedownstreamindustry. A clear case where this
has occurred is in the domesticleather industry,which has been taxed in
order to provide cheap inputs into that (small)part of Indonesia'sfootwear
industrywhich sells solely on the domesticmarket.15/

5.52 In line with the recommendations

made in the Bank's recent Tree Crops
report, all export restrictionson commoditiesin this category should be
removed. This should include the removal of market allocations,export or
inter-islandtaxes, and controlleddomesticprices.

14/ An example of the type of economicanalysis requiredto determine if an

export tax is appropriateis providedin the World Bank's recent report
on the IndonesianTree Crops Sector - No. 7697-IND.

15/ See Chapter 3, footwearcase-study.

 - 125 -

Export Assistance

5.53 BAPEKSTA. The duty exemption facilityoperatedby BAPEKSTAoperates

efficientlyand has providedessentialsupport to Indonesia'sexpandingnon-
oil exports. Firm level interviewsin both the industrialand agricultural
sectors confirm how importantBAPEKSTAhas been in providing direct access to
importedinputs at world prices and as a mechanism to increasethe competitive
pressures on domestic suppliers.16/ However, the rapid growth of
utilizationsof BAPEKSTA'sservices (currentlyover 20Y of non-oil exports)
has placed a strain on staff resources. In addition,the duty drawback
mechanismhas not been widely used (see Chapter 2), largelybecause of the
requirementthat suppliers furnish informationto the exporter on their import
costs and duties.

5.54 In the near terw, to ensure that the efficiencyof the exemption
mechanism is maintained,t- est additionalstaff resourcesand some technical
assistanceshould be considered. This should be coupledwith continued
efforts to improve the transparencyand efficiencyof BAPEKSTA'soverall
operation. An importantcomponentof improvingBAPEKSTA'soperationswill be
to simplifyapplicationproceduresin an effort to be encouragemore small-
scale or new exportersto apply. BAPEKSTA'soperationscould also be improved
by modifying the system for grantingduty drawbackto encouragegreater
participationby indirectexporters. One option would be to use the domestic
LIC system introducedby Bank Indonesia in October 1988 as an administrative
mechanism. Under this option the master export LIC, the domesticLIC and the
LIC opened by the commercialbank on behalf of the indirectexporter to import
foreign inputs should togetherconstitutethe proof needed by P4BM to grant
prior exemption for duty free imports for the indirectexporter. To ensure
that importedinputs resultedin exports,P4BH can apply the same procedures
as it currentlyapplies for the direct exporter.

5.55 While every effort should be made to increasethe efficiencyof

BAPEKSTA, this should not be viewed as a substitutefor continuedaction to
reduce import policy distortionsdirectly. The removal of NTBs and reduction
and rationalizationof import tariffs,discussedearlier in this Chapter,will
reduce the incentiveto use BAPEKSTA,thereby freeingvaluable staff resources
to focus on broadeningaccess to the scheme to cover small-scaleand indirect
exporters.

5.56 Export Credit, Guaranteeand Insurance. The existingexport

financing,loan guaranteeand credit insuranceschemeshave supportedthe
rapid growth in Indonesia'snon-oillLNGexports in the last few years.
However, as discussedin Chapter 2, the existingschemes appear to have had
only limited impact on broadeningthe export base or facilitatingbackward
linkages,due to a number of drawbacks:(i) te preferentialinterest rates
charged to the exporterhave encouragedmisuse of the export loan, whereby
funds have been divertedby the borrower for purposes other than exports;
(ii) rationingof credit has restrictedits use principallyto large,
establishedexporters; (iii) the low intermediationmargins on export loans as
compared to other commercialloans have discouragedcommercialbanks from

161 See Chapters2, 3 and 4.

 - 125 -

Export Assistance

5.53 BAPEKSTA. The duty exemptionfacilityoperatedby BAPEKSTA operates

efficientlyand has provided essentialsupport to Indonesia'sexpandingnon-
oil exports. Firm level interviewsin both the industrialand agricultural
sectors confirm how importantBAPEKSTAhas been in providingdirect access to
importedinputs at world prices and as a mechanism to increasethe competitive
pressureson domestic suppliers.16/ However, the rapid growth of
utilizationsof BAPEKSTA'sservices (currentlyover 202 of non-oil exports)
has placed a strain on staff resources. In addition,the duty drawback
mechanism has not been widely used (see Chapter 2), largely because of the
requirementthat suppliers furnish informationto the exporter on their import
costs and duties.

5.54 In the near term, to ensure that the efficiencyof the exemption
mechanism is maintained,modest additionalstaff resourcesand some technical
assistanceshould be considered. This should be coupledwith continued
efforts to improve the trastsparencyand efficiencyof BAPEKSTA'soverall
operation. An importantcomponentof improvingBAPEKSTA'soperationswill be
to simplifyapplicationproceduresin an effort to be encouragemore small-
scale or new exporters to apply. BAPEKSTA'soperationscould also be improved
by modifying the system for grantingduty drawbackto encourage greater
participationby indirectexporters. One option would be to use the domestic
LIC system introducedby Bank Indonesiain October 1988 as an administrative
mechanism. Under this option the master export L/C, the domesticL/C and the
L/C opened by the commercialbank on behalf of the indirectexporter to import
foreign inputs should togetherconstitutethe proof needed by P4BM to grant
prior exemption for duty free imports for the indirectexporter. To ensure
that imported inputs resulted in exports,P4BM can apply the same procedures
as it currentlyapplies for the direct exporter.

5.55 While every effort should be made to increasethe efficiencyof

BAPEKSTA,this should not be viewed as a substitutefor continuedaction to
reduce import policy distortionsdirectly. The removal of NTBs and reduction
and rationalizationof import tariffs,discussedearlier in this Chapter,will
reduce the incentiveto use BAPEKSTA,thereby freeingvaluable staff resources
to focus on broadeningaccess to the scheme to cover small-scaleand indirect
exporters.

5.56 Export Credit, Guaranteeand Insurance. The existingexport

financing,loan guarantee and credit insuranceschemeshave supportedthe
.apid growth in Indonesia'snon-oil/LNGexports in the last few years.
However,as discussed in Chapter 2, the existing schemesappear to have had
only limited impact on broadeningthe export base or facilitatingbackward
linkages,due to a number of drawbacks:(i) te preferentialinterestrates
charged to the exporterhave encouragedmisuse of the export loan, whereby
funds have been diverted by the borrowerfor purposesother than exports;
(ii) rationingof credit has restrictedits use principallyto large,
establishedexporters; (iii) the low intermediationmargins on export loans as
comparedto other commercialloans have discouragedcommercialbanks from

16/ See Chapters 2, 3 and 4.

 - 127 -

willfulnoncompliance in whichcase the claimshouldbe totallyrejected.To

checkthe appropriateness of the premiumit may be necessaryto reviewthe
experiencewith the PEFG portfolio, to analyzethe main causesof defaultand
to findways to minimizethe exporters' non-performancerisk. An in-depth
analysisof claimswouldclearlydistinguish the legitimate claimsassociated
with exporters'non-performance fromthoseassociated with exporters'
deliberatedefaultand misuse.
5.61 The efficiencyof administeringPEFG requires:(i) closecoordination
betweenpreshipment exportfinanceguarantee(i.e.,PT. ASEI)and the pre-
shipmentexportloandisbursement mechanism(i.e.,Bank Indonesia); (ii)PEFG
beneficiariespayingthe actualcost throughappropriate premiumrates;and
(iii)operational effectiveness
in the information-gatheringand risk-pooling
functions.Over timeand afterthe institution buildingphaseis substantially
completed,the PEFGagencycan alsoplay an importantrolein the risk-
reductionby channelingtechnicalassistance, eitherdirectlythroughin-house
activitiesor indirectlythroughotherspecialized agencies.
5.62 Finally,with respectto the ExportCreditInsurance/Guarantee
program,the most importantstepthat can be takento encourageits use is to
familiarizethe banksand exporterswith its availability and advantages
throughan active,targetedmarketingcampaign. In addition,new insurance
policieswouldneed to be designedto coverspecificmedium-term transactions,
salesof services, unconditionalguaranteeto banks,etc. Unconditional
insurancecoveragefor banksis offeredin many countriesto facilitate
financingof exporters'saleson usuanceterms. Whilenon-oil/LNG exportsare
on sightLIC terms,in many caseswherebanksrelyupon the L/C as security
for advances.they obtainconfirmation of the L/Cs fromoffshorebanks.
Insuranceto bankscoveringL/Cswouldbe an alternative to seeking
confirmationoffshore. Insurancefor L/Cs is iresently availablefor
exporters,but not for banksexceptunderan insurance policyassignment.It
should,however,be borne in mind thatat the presentstageof Indonesia's
development,PEFG is more importantas an effectiveinstrument of export
expansionthanECIIG. Thisis becs-uea very largeproportionof totalnon-
oil/LNG exports are destined for markets -- USA, Japan and EEC -- with little
politicalas well as transferrisks.
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27 TIMORTIMUKL
KILOMJETERS

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FEBRUARY