In spite of a raft of strategic development plans laying out a path towards a more diversified, modern economy with greater contributions from high-value-added industries, agriculture remains a fundamental sector for the country in both financial and social terms. Indonesia’s expansive territory and favourable soil and climate have given rise to a host of homegrown agro-industrial giants as well as drawn the attention of some of the world’s largest international food processors. Valued at Rp1560trn ($113.9bn), the agriculture sector comprised 13.5% of Indonesia’s GDP in 2015, according to data from the Bank Indonesia.
Led by the palm oil segment, plantation crops accounted for the greatest percentage of this figure in 2015, being valued at Rp411.9trn ($30.1bn), and followed closely by food crops at Rp393.4trn ($28.7bn). Other significant cash-generating estate crops include sugar, rubber, cocoa, coffee, tea, sugarcane and tobacco. The fisheries sector was also a major contributor valued at Rp292.1trn ($21.3bn) for 2015, with smaller contributions being made by the livestock industry, valued at Rp183.4trn ($13.4bn), horticulture crops at Rp175.2trn ($12.8bn), forestry and logging Rp81.7trn ($6bn), and agricultural services Rp22.7trn ($1.7bn).
Robust Gains
Figures from the Ministry of Agriculture reveal strong production gains across a number of key crops and products including rice, corn and livestock in 2015 and early 2016, in line with the targets set by the incoming administration of President Joko Widodo. These gains were recorded in spite of the potentially negative effects brought about by El Niño in 2015 and 2016, which was widely expected to curb output.
The continued strong showing and substantial growth potential have resulted in significant amounts of investment in recent years at levels far outpacing other economic sectors in the country, with the exception of manufacturing. In 2015 investment in agriculture and forestry totalled $3.97bn; equivalent to approximately one quarter of the $15.51bn in total investment recorded for the year. These levels of spending were on par with 2014, when $3.96bn was channelled into the sector, but represents a marked increase from previous years when annual inflows totalled $1.2bn in 2012 and $1.9bn in 2013.
Raising The Bar
As trade barriers continue to erode and international competition becomes increasingly intense in both domestic markets and abroad, Indonesian farmers are becoming increasingly efficient in their operations. These efforts are being carried out both by the private sector with large agribusiness companies investing heavily in research and development, mechanisation and irrigation, alongside government and international donor programmes targeting primarily smallholder farmers who often lack the scale and resources to boost yields on their own.
Among the most prominent of these domestic projects is the PISA gro programme launched by the government in 2011, which targets a 20% increase in agricultural productivity, a 20% increase in farmers’ income and a 20% decrease in greenhouse gases over time. The programme also relies heavily on public-private partnerships, having successfully enlisted the support of several key private sector companies for its projects including Bayer Cropscience, Indofood, McKinsey, Nestlé Indonesia, Sinar Mas, Syngenta and Unilever.
These programmes focus on a number of key priorities for improving the productivity of a wide range of crops and offer assistance in the form of facilitating access to financing for small farmers through loans and credit, training programmes, and access to crucial inputs such as water, fertiliser, tools and other inputs. Although generally successful in achieving their targets of boosting productivity in a sustainable manner while improving the lives of farmers, these programmes previously have been limited in their impact due to their smaller scale. More recently PISA gro has been looking to shift this trend by substantially improving the scope and magnitude of its activities. “We have always been branded as producing small-scale pilot projects. We want to move away from this and scale up five commodity groups: palm oil, coffee, cocoa, rice and corn,” Danumurthi Mahendra, former executive director of PISA gro, told OBG.
According to Mahendra, the new, larger scale programmes will address traditional areas of financing, training, inputs and other components through partnerships with local Indonesian agriculture companies rather than multinationals. Funded largely by matching grants provided by NGOs and the private sector, the expanded initiatives will focus not only on boosting upstream yields but also on post-harvest activities such as improvements in farm-to-market operations or proper storage and off-take practices and the bolstering of milling operations for rice and corn crops.
“With corn, for instance, we need a higher quality of output from farmers – we have high-quality seeds, but no follow through in post-harvest practices,” said Mahendra. “The problem is that the off-take buyer ends up spending a lot of money to make sure the product meets its standards because the products are too dirty or too wet.”
Although still in their infancy, programmes such as PISA gro and other development initiatives have so far achieved marginal effects in terms of curbing the country’s reliance on food imports, with Indonesia purchasing $1.3bn worth of foreign foods and beverages for household consumption in 2015. These purchases are consistent with previous years, in spite of a growing population, with unprocessed food imports of $1.54bn in 2014, $1.4bn in 2013, $1.54bn in 2012 and $1.8bn in 2011. Indonesians purchased even more foreign-sourced processed food and beverages for household consumption, which were valued at $2.8bn, $2.8bn and $2.3bn, respectively, in 2013, 2014 and 2015.
Farm To Market
While programmes such as PISA gro and similar initiatives aim to boost yields in an effort to make farmers more efficient, the government is also tackling the problems associated with high production costs by improving supporting infrastructure such as water access and transportation routes to move goods from the farm to vendors or export points. Because spending on basic infrastructure in Indonesia has lagged well behind regional competitors for decades, the country as a whole lacks the modern infrastructure necessary to compete in a contemporary agri-business environment, which requires the support of an ample and consistent water supply, efficient road and rail networks and a system of modern ports to ship goods both domestically and internationally.
“The challenge for all crops is supply chain efficiency, and we have bad infrastructure. This is also contributing to increased costs as a result of so many middlemen,” Widyantoko Sumarlin, general manager of business development for the crumb rubber processor unit of Kirana Megatara Group, told OBG. “This also affects farmers’ access to financing and inputs like seedlings and fertiliser.” A solution to these problems appears to be closer at hand as of 2016, however, as the government has poured in a massive budgetary infusion to overhaul these key sectors starting in 2015. Many of the most recent infrastructure projects affecting the agriculture sector are focused initially on the rice segment, specifically through enhanced irrigation efforts and shoring up road infrastructure along rice producing areas. Further plans for the redevelopment of numerous ports around the country and an extensive nationwide roadworks programme are also expected to improve logistics for a much wider array of commodities.
Palm Oil
The rise of the palm oil industry over the past two decades has proven to be an unprecedented boon for Indonesia’s agriculture sector as production of the commodity has grown exponentially to become the primary driver of the industry and one of the country’s most lucrative exports. Together with Malaysia, the two countries dominate the global crude palm oil (CPO) market and are responsible for 85-90% of total worldwide output. Shipped to markets around the world, the two countries have engaged in a long-running competition over the past 15 years in order to supply demand, which has been increasing in line with the overall expansion of the world’s population. The large, export-oriented palm oil companies operating in Indonesia have grown into international agri-business powerhouses in their own right and include the likes of Astra Agro Lestari, Indofood Sukses Makmur, Sinar Mas, BW Plantation, Bakrie Sumatera Plantations, Wilmar Group, Sampoerna Agro, Musim Mas Group, Raja Garuda Mas and PP London Sumatra Indonesia.
In spite of soft commodity prices, which have yet to recover from the highs achieved in 2011, Indonesian CPO production continues to make gains as the industry pushed through the 30m-tonne barrier in 2015 with a total output of 31.28m tonnes, according to data from the Ministry of Agriculture. Figures announced by the Indonesian Palm Oil Association (IPOA) put production levels slightly higher at 32.5m tonnes on the year. This output reflects the delayed effects of El Niño, which is expected to reduce production to around 32m tonnes in 2016 due to the lack of rainfall in 2015.
Rapid Expansion
This new high marks the pinnacle of an unprecedented expansion in capacity for palm oil producers, who ratcheted up their efforts in the early 2000s by adding millions of tonnes of production over the next decade. After increasing slowly but steadily from 4.5m tonnes to 11.9m tonnes of CPO over the decade between 1995 and 2005, increasing output by 7.4m tonnes, a wave of expansion in the decade up to 2015 fuelled growth to 19.4m tonnes of new production.
This palm oil boom was the result of a dramatic increase in planted palm acreage, rather than any substantial increase in yield per acre. In 1995 there was less than 1m ha of palm oil trees planted across the country, which grew robustly for the next decade as the cultivated area more than doubled to 5.5m ha by 2005. Competing at this point with Malaysia for global market share, new plantings increased over the next 10 years as the area devoted to palm oil doubled again, adding another roughly 5m ha for a total of 11.3m ha by 2015.
While this rapid proliferation was good for business, the wholesale conversion of land into palm plantations also drew the attention of NGOs and other parties concerned about the environmental damage caused by the increased release of carbon dioxide and greenhouse gases. Moreover, some of the larger and more image-conscious purchasers of palm oil in developed markets also became responsive to the negative publicity these practices were having on their own companies, and pressure began to mount on producers to adopt more sustainable business practices.
RSPO
The result of this movement was the creation of the Roundtable for Sustainable Palm Oil (RSPO) in 2004, which strived to create an industry-wide framework to provide certification for sustainable farming practices. While RSPO standards have been effective in establishing credible and internationally accepted certification, only 17% of palm oil was accredited in 2016 due to the time consuming and costly nature of the process, which is borne primarily by farms and estates rather than manufacturers or retailers. Smallholders in particular are at a disadvantage due to their inability to fund the certification process. Looking to remedy this dilemma, Indonesia developed its own certification system in 2011, dubbed the Indonesian Sustainable Palm Oil (ISPO). Similar in many respects to RSPO but billed as a less costly and less complicated alternative for domestic producers, ISPO certification was to be required by all producers by December 31, 2016. Due to a lack of incentivisation in the voluntary RSPO programme, only a fraction of Indonesia’s producers had obtained accreditation as of mid-2016 and the target date was subsequently moved back until 2020.
Moreover, the Indonesian government has initiated a moratorium on issuing permits to clear land for the purpose of new plantations. First enacted in 2011, the moratorium has since been extended twice and is expected to remain in place through to 2017. Although the ban has had a limited effect so far due to the extensive land banks established by companies prior to the restrictions, a slowdown in expansion is still expected. A reduction in seed purchases will take effect in coming years as maturing trees decline in productivity with a smaller number of new plantings arriving to take their place. Additionally, much of the recent increase in acreage is largely the result of smallholder growth, which is not subject to the moratorium. Since 2011 smallholders have increased their palm oil land from 3.75m ha in 2011 to 4.58m ha in 2015.
Incentives
Putting the environmental benefits to one side, adopting sustainable certification has so far limited the financial benefits for producers as the market has as yet failed to generate premium pricing for sustainable products compared with non-certified CPO. This lack of incentives could be changing in the future, however, as markets become more discerning. For example, the EU has mandated that all CPO imported into the block be certified by 2020, although the exact criteria defining what is “sustainable” has yet to be set. France has gone one step further in the meantime by instituting a tax ranging from € 30-in 2017 and increasing over time. Regardless of the potential benefits of certification, many of the larger palm plantation companies in Indonesia have already adopted the practices. “Instituting sustainable practices is not about finding premium prices for CPO, but about a commitment to doing things the right way, whether that is through RSPO or ISPO or another certification,” Fadhil Hasan, executive director of the IPOA, told OBG.
Boosting Demand
The country’s own domestic population also represents a sizeable market opportunity for future growth in the palm oil sector, as the government continues in its efforts to boost downstream value-added activities.
One of the largest opportunities, still in its early stages, is the biofuels market, which was launched in 2015 when the government called for a mandatory biofuel blending of 20% in diesel fuel. The move increased biodiesel subsidies and raised the minimum biocontent in diesel fuel from 10% to 15% in 2015. This will be followed by 20% biocontent in 2016 and 30% in 2020. “With global demand uncertainty continuing and economic growth in China slowing, the challenge is to get the mandatory biodiesel programme to run smoothly in order to absorb CPO on the domestic market and reduce dependency on the export market,” Hasan said.
To support the programme, a new government agency named Indonesian Oil Palm Estate Fund (BPDP) was established in 2015 and charged with collecting the export tax levied on the palm oil sector, the funds of which are then channelled towards sustainable activities; primarily for subsidising palm-based biofuels and replanting efforts for smallholder farmers. The levies amount to $30 per metric tonne for processed palm oil and $50 for the same amount with CPO if prices fall below $750 per metric tonne, which is the threshold where the existing export tax is cut to zero. The early results of the plan have been mixed, as the programme has experienced growing pains with its supply and distribution network. There are also financial issues with subsidies, as lower international fuel prices have made it more challenging for biofuels to compete with conventional petroleum products.
The distribution of blended biodiesel reached approximately 404,000 kilolitres (kl) during the first two months of 2016, roughly 80% of the more than 500,000-kl target set for the period, according to statements by the BPDP to the local press.
State-owned oil and gas firm Pertamina has set a target to use up to 4.5m kl of biofuel to be mixed in to subsidised and non-subsidised biodiesel in 2016. Of this total amount, 3.2m kilolitres of biofuel will be used for subsidised biodiesel, which is expected to reach 16m kl for the entire market by the end of 2016. The remaining 1.3m kl of Pertamina’s biofuel output will be used for non-subsidised diesel.
In addition to boosting local demand through biofuel requirements, the government is also encouraging more downstream processing in the country through its scaled tax structure, which underwent a reconfiguration in 2015. Under the previous system implemented in 2011 – amidst a period of robust commodity prices – CPO was taxed on a sliding scale from as little as 7.5% to as much as 22.5%, with the effective tax rate dependent upon the market price for the commodity.
In practical terms, for every $50 increase in market price, the export tax increases by 1.5% (so higher prices also bring progressively higher tax rates), starting at an export price of $750 per metric tonne. But with prices failing to rise over the minimum $750 level in recent years, exports have remained largely untaxed, prompting changes to the 2015 tax code that require that a $50 per metric tonne levy is imposed on CPO exports, and a $30 per metric tonne levy is imposed on exports of processed palm oil products. If prices continue to increase over $750 per tonne, this new tax kicks in and increases incrementally for every $50 price rises, starting at $3 per tonne up to $80 per tonne. A cap of $200 per tonne is then introduced when prices exceed $1250 per tonne.
Adding Value
In line with the government’s overarching strategy to diversify its economy and move up the value chain, Indonesia’s well-established downstream rubber sector is home to many of the world’s largest tire companies including Bridgestone, Continental, Goodyear, Michelin and Sumitomo. In total, the rubber, plastic products and rubber-products manufacturing segments contributed Rp86trn ($6.3bn) to Indonesia’s GDP in 2015, up from Rp80.3tn ($5.9bn) in 2014.
Processed rubber products also make up nearly all of the rubber industry’s exports, with companies exporting 3.3m tonnes of processed rubber products valued at $5.8bn in 2015, compared to just one tonne ($11m) of natural rubber exported in the same year. This level of output was consistent with shipments made the past two years, but represents a significant increase over previous years when exports tallied 2.2m tonnes and 2.3m tonnes in 2004 and 2005, respectively.
The sector has attracted so much investment that it has become something of a victim of its own success, as the excess capacity of rubber processors now boasts a combined total capacity nearly double that of actual production, forcing processors to operate at levels far below their maximum efficiency. “This does not encourage farmers to improve the quality of their crops because the processors are under-supplied,” Daniel Tirta Kristiadi, managing director of the crumb rubber processor unit of Kirana Megatara Group, told OBG. “So it is very important to replant and also increase the productivity of farmers as well as to discourage the addition of new capacity.”
According to Kristiadi, Indonesian processors must expend roughly twice the energy and three times the water to clean and process raw rubber compared to their counterparts in other countries such as Vietnam, due to the lack of upstream quality control and the desire of processors to purchase all output in order to fill unused capacity.
Outlook
Indonesia’s agriculture sector contains a substantial amount of untapped potential. For example, development programmes and assistance projects funded by the government – or investment by donor organisations and the private sector – are expected to improve relatively low yields for a large number of crops, such as tobacco. Although Indonesia currently imports around 30-40% of its tobacco, it is thought that domestic yields could be increased by improving agricultural practices through educating farmers in the use of pesticides and fertilisers.
The significant amount of infrastructure development projects rolling out across the country should also help to boost the competitiveness of Indonesia’s growers on the global export market as well leading to expected economic benefits through lowering production and logistics costs.
In addition to the growing international demand for agriculture products, domestic demand for these goods is also expected to grow as the country’s downstream food and beverage segment continues attracting significant levels of investment.
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