The third-largest contributor to Indonesia’s national economy behind the oil and gas sector and industrial manufacturing, Indonesia’s agricultural sector maintains a crucial role both in supplying the nation’s domestic market as well as providing an attractive supply of exports. As the country’s economy continues to expand and diversify, the agriculture industry is shifting away from being a principally raw material exporter towards being a value-added base for global agro-industry.

Keeping an eye on the domestic market, the government has also implemented a raft of new policies to shore up domestic food production and security in response to dramatic agricultural commodity price swings in international markets in recent years.

Through the first nine months of 2012, the agricultural sector accounted for 15% of Indonesia’s GDP and attracted 7% of total investment, according to the Central Statistics Agency (BPS). Preliminary figures indicate that the agriculture, livestock, forestry and fishery sector contributed some Rp1093.47trn ($109.3bn) to the economy, up from Rp985.45trn ($98.5bn) recorded the previous year. Of the 2011 figure, food crops were the largest contributor at Rp530.6trn ($53.1bn), followed by fisheries at Rp227.78trn ($22.8bn), estate crops (Rp153.88trn, $15.4bn), livestock (Rp129.58trn, $13bn) and forestry (Rp51.64trn, $5.2bn).

PROCESSING PALM OIL: The palm oil sector is now experiencing a similar wave of downstream investments following the implementation of a comparable export tax system in 2011. Investments totalling some $2.5bn are being channelled into the country and are expected to boost domestic palm oil refining capacity to 43m tonnes, good for 80% of total global output and substantially more than the country’s current production rate of 23m-25m tonnes per annum. Although this rapid influx incapacity will boost the more profitable refined oil output, the impending supply glut may also lead to softer commodity prices and lower margins.

“This move is certainly encouraging investment in downstream operations,” said Jean Louis Guillou, Cargill Indonesia’s country head and general manager. “It will be interesting to see over the long term if the incentives and economic stimulus provided to the downstream industry will outweigh the loss of revenue in upstream industries like plantations and small holders.”

Although the full effect of the new palm oil tax scheme has not yet been felt in the sector, an estimated 7m-10m tonnes of new refining capacity is planned. The country’s advantage in the refined palm oil market over its rivals may be short-lived, however, as the second-largest palm producer, Malaysia, countered in 2012 with legislation of its own. Scheduled to take effect in January 2013, the Malaysian government has eliminated export tax on crude palm oil (CPO) and on refined palm products (see analysis).

COCOA: One of the country’s premier cash crops providing a vital source of income for farmers (97% of cocoa is cultivated on smallholder farms), cocoa exports remained robust before slumping in 2012 due in part to change in export policies. Production for the world’s third-largest cocoa producer totalled 435,000 tonnes in 2011 with the 2012 outlook forecasting a crop of 435,000-450,000 tonnes. The majority of the country’s 1.5m ha of cocoa farms are located in Sulawesi (64%) and Sumatra (23%) with the remaining acreage spread across the rest of the county.

The cocoa industry experienced a shake-up in 2010 with the implementation of a new export tax designed to boost processing in the country by raising export taxes on raw cocoa beans. Similar to the new CPO export tax, the cocoa duty is levied on a sliding scale ranging from 0% to 15% depending on the market price of the commodity. Although the measure has dramatically boosted domestic grinding capabilities, production and exports have dropped off greatly leaving a substantial portion of this new processing capacity lying idle.

IMPACT ON EXPORTS: After experiencing a compound annual growth rate of 10.62% over a five-year period culminating in export revenues of $1.64bn in 2010, the value of cocoa and cocoa preparations shipped dropped some 18% in 2011 to $1.35bn, according to the Ministry of Trade. This trend continued in 2012 with exports falling 20.32% in the first eight months of the year compared to the same period in 2011.

The policy has been successful in boosting processed cocoa products, however, which rose from 150,000 tonnes in 2010 to 250,000 tonnes in 2011, according to data from Indonesian Cocoa Association (ASKINDO). This included an annual spike of 59.1% for cocoa shells, husks, skins and other products from 2010 to 2011, along with other increases across the board for cocoa paste (29.7%), wholly or partly defeated cocoa paste (51.8%), cocoa butter, fat and oil (27.7%) and cocoa powder containing added ingredients (54.6%).

There was, however, a downside to the rise in refined exports in that shipments of traditionally exported raw beans plummeted from 432,305 tonnes to 210,067 tonnes in one year. Primary importers of Indonesian cocoa products include Malaysia, Singapore, the US, Thailand and China. The domestic market has significant potential to take up some of the excess processing capacity currently built up. As of 2011, annual domestic consumption for the nation of 242m people stood at just 0.2 kg per capita, according to ASKINDO.

ADDING VALUE: Another overarching principal of the country’s long-term agribusiness strategy is boosting value-added processes in the downstream sector. Generally carried out through a regulatory framework of incentives, import and export tariffs, trade restrictions and other non-tariff barriers, these strategies are being employed for a number of key industries, including mining and energy, as well as agriculture. Having added extra taxes on raw material exports, the government also provided incentives such as tax allowances, exemptions from import and value-added taxes and other tax holidays for companies investing in specific downstream industries, including palm oil, cocoa, rubber and other agricultural commodities.

Two key examples of how this strategy is transforming the domestic agribusiness landscape lie in two of Indonesia’s most important export crops – palm oil and cocoa. Both have been the subject of drastic tax structure reform in the past few years, which has resulted in considerably higher export taxes on raw materials, thus lending considerable financial incentive for companies to invest in greater processing capabilities.

DOWNSTREAM DEVELOPMENT: Implemented in 2010, the 0-15% sliding scale export tax on raw cocoa beans has had a measurable impact on the export composition of the commodity. The new regulations have also been extremely effective in stimulating investments in the downstream grinding sector, with the country boasting a total installed capacity of 864,000 tonnes in 2012, up from 624,000 tonnes in 2011, according to data from ASKINDO. Much of the expansion has come in the form of foreign direct investment, with approximately 78% of grinding capacity operated by non-Indonesian companies. Additional planned outlays in the pipeline are expected to further bolster this figure to 854,000 tonnes in 2013, more than three times the installed capacity available in 2007. The industry’s processing ability now more than doubles actual output, leaving substantial capacity idle. Although Indonesia did increase its refined cocoa exports significantly to 250,000 tonnes in 2011, this amounted to less than half of the 624, 000-tonne capability of its infrastructure.

FOODSTUFFS: The government has become increasingly aggressive in its bid to curtail the substantial food imports and move towards self-sufficiency. Various national strategies and plans have been implemented to support these aims, such as the Indonesian Chamber of Commerce and Industry’s (KADIN) food development programmes, Vision 2030 and, most recently, the passage of the new Food Law in October 2012 replacing prior 1996 legislation (see analysis).

Recent government efforts to meet food security objectives appear to be having moderate success as the harvests of basic foodstuffs including rice, maize, cassava and soy bean have all increased in recent years. Production, harvested area and productivity of the strategic food crops as outlined in these strategies — rice, corn and soybeans – have all grown significantly since 2007. The harvested area for rice cultivation increased from 12.15m ha in 2007 to 13.57m ha in 2011, leading to a corresponding rise in production from 57.16m tonnes to 68.06m tonnes, according to BPS data. Corn production showed similar gains over the same time period, increasing in acreage (3.63m ha to 3.9m ha) and production (13.29m tonnes to 17.39m tonnes), while also displaying impressive growth in productivity, which rose from 36.60 quintal per ha to 44.64 quintal per ha. While still not grown on a large scale in Indonesia, soy bean cultivation increased modestly from 459,100 ha to 592,000 ha along with a parallel rise in production from 592.5m tonnes to 819.4m tonnes.

Despite increases in production, foreign trade officials announced in November 2012 that the country was seeking to procure an additional 100,000 tonnes of rice from India through a tendering process. The deal would supplement earlier agreements to bring in 300,000 tonnes from Vietnam.

INTERNATIONAL EFFORTS: One recent government initiative designed to achieve these production goals is the Partnership for Indonesian Sustainable Agriculture (PISA gro), which was announced during the World Economic Forum – East Asia in June 2011. It is hoped by those involved that PISA gro can gain traction where previous government initiatives have stalled through employing the participation of many of the world’s top agribusinesses, which include founding members Indofood, Nestlé, Sinar Mas, Syngenta and Unilever. PISAgro’s aims include boosting domestic production of key commodities like corn, soybeans, rice, poultry, livestock and aquiculture through a new concept of innovative financing; however, this is a relatively ambiguous title that belies its scope and ambition.

The basic aim of the programme is to take the components that have propelled the palm oil industry to success and apply them to other crops. The linchpin of this plan is the vertical integration of international agribusinesses across the entire value chain. Where large-scale plantations such as Wilmar, Cargill and others, realise efficient and profitable production through all aspects of the business chain, from seed distribution to farm management and oversight, to transportation, processing facilities and refining, this model has not succeeded in most other agricultural sectors.

The model does not, however, squeeze out all smallholder farmers that form the traditional backbone of the palm oil sector and still make up a substantial employment block. In the palm industry, roughly 50% of output is derived from the large-scale company-held plantations, with a 42% contribution from smallholders and the remaining 8% by state-owned firms.

A new development being championed by KADIN that should stimulate investment is the rollout of Indonesia’s new crop insurance scheme. Expected to be popular among large estates and smallholders alike, approval for the project was expected before the end of 2012 after conferring with financial institutions, insurance carriers, farmers, suppliers and retail sector.

SAVING FOR A RAINY DAY: In addition to long-term strategic plans and legislation codifying self-sufficiency doctrine into law, the Indonesian government has sharpened another tool in its food security agenda when it substantially expanded the scope of the National Logistics Agency (BULOG). The move was announced in August 2012 by President Susilo Bambang Yudhoyono, who stated that he was calling for the revitalisation to “give it concrete functions so that it can carry out its duty as a price stabiliser”. Responsible for procuring, storing and distributing strategic commodities such as rice, the body’s primary function is to stabilise key agricultural commodities so as to ensure adequate domestic supplies insulated from external price shocks.

According to BULOG, the agency has “a commitment to generate revenues, but a social commitment at the same time; its revitalisation process is intended to boost both functions of the organisation. From the public service obligation, the company can do more managing the price of a number of additional staples, and from the revenue function by diversifying products and growing in services and businesses.”

UNDER THE UMBRELLA: As part of its expanded role, BULOG will include other commodities under its umbrella, such as soybeans, beef, corn and sugar. Previously the agency’s role was limited to overseeing rice, including imports of the staple if necessary, for which it generally maintained stockpiles of between 1.5m and 2.5m tonnes in the past. These reserves are projected to expand dramatically over the next two years, with the government targeting a supply of 3.9m tonnes of rice in 2013 and 10m tonnes in 2014. Complementing its growing stable of crops, BULOG’s authority has also been bolstered by allowing streamlining the process regulating how and when it may intervene in the markets. Rather than waiting until commodity prices rise by 20% over a specified period of time before being allowed to act, BULOG is now freed to move more proactively as soon as price irregularities are observed.

PROVIDING A SAFETY NET: The recent actions to bolster the entity’s capabilities stemmed in part from a spike in corn and soy bean prices in the summer of 2012. Caused by a poor harvest in the US as the result of the worst drought to hit the country if more than 50 years, the rapid price escalation of the key food staples highlighted Indonesia’s – as well as other nations’ – vulnerability to such price shocks.

One the first major procurement actions carried out by the agency under its revised mandate was an October meeting with US government officials to discuss securing additional soy bean imports. In addition to providing a safety net and stabilising prices, the agency could also provide a counterweight to some sectors dominated by oligopolies.

The larger role for BULOG is nothing new for the agency, as it handled the procurement of the nation’s nine staple foods, including rice, corn, salt, sugar and cooking oil, prior to the Asian financial crisis in the late 1990s. However, the agency’s monopoly on agricultural imports was halted in 1998 along with tariff reductions and the ending of fertiliser subsidies as part of the requirements imposed by the IMF through its structural adjustment programmes that favoured privatisation and a host of other free market mechanisms. With its expanded powers, BULOG should be in a stronger position to buffer food commodity spikes, although concerns remain among some food producers and trade organisations that import and export restrictions have the potential to fuel food inflation and create an environment which could bring about the market instability the measures were intended to combat.

These concerns were voiced in a report on Indonesia’s agricultural policies released in October 2012 by the OECD. In specifically addressing the expanded powers afforded to BULOG, the report called for reforming Indonesia’s export taxes and import curbs on farm commodities in order to stimulate investment and improve national food security. In the eyes of the OECD, import protection hinders competitiveness of the farm sector, limits productivity and growth, and increases food costs for poor consumers. As an alternative to increasing trade barriers for the sector, the report suggested alternative methods to boost investment in the domestic market, including replacing Indonesia’s fertiliser subsidies with a voucher scheme, improving water supplies, further diversification away from rice, and stronger education and retraining programmes for agriculture workers seeking new career opportunities.

COFFEE: Bolstered by favourably moist weather, Indonesia’s coffee production is projected to achieve as much as 700,000 tonnes in 2012, a 17% increase over the previous year, according to estimates by the Association of Indonesian Coffee Exporters and Industries (AEKI). Suyanto Husein, the chairman of AEKI, attributed the strong production figure to the crop’s cyclical nature as well as to favourable weather during the flowering season. Without a substantial increase in cultivated land, coffee production has remained flat for the past five years, with previous annual output levels from 2007-09 registering 652,300 tonnes, 669,900 tonnes and 653,900 tonnes, respectively, according to the BPS. Exports are expected to reach similar levels to 2011 at 350,000 tonnes, with the primary importers being Japan, Germany, the UK, Italy, the US and Malaysia.

The vast majority – around 95% – of Indonesian coffee is cultivated by smallholder farmers that generally work plots of less than 2 ha in size. Added together, the working coffee acreage in the country totalled around 1.3m ha in 2011, with the majority of production located in the two provinces of Sumatra and Lampung.

As one of the government’s six superior export commodities, according to its food sector development plan, coffee production is projected to rise to 798,000 tonnes by 2015 and 975,000 tonnes by 2025. This growth is set to be achieved through both an increase in coffee cultivation area from current levels of 1.3m ha to 1.5m ha by 2025, as well as boosting productivity from 0.5 tonnes per ha to 0.7 tonnes per ha.

TEA: Despite a slowly shrinking amount of plantation area dedicated to tea cultivation, Indonesia remains among the world’s largest producers of this crop. Out of a total global tea harvest of 3.9m tonnes in 2010, Indonesia was the eighth-largest grower with 150,300 tonnes produced, according to the UN’s Food and Agriculture Organisation (FAO). This ranked behind tea-producing powerhouse China, India, Kenya, Sri Lanka, Turkey, Vietnam and Iran. Indonesia exported more than half its output in 2010, shipping 87,100 tonnes worth $178m to over 40 countries. This was down from 92,300 tonnes in 2009. As competition continues to intensify for arable land, production is predicted to drop by 1.1% from 2011 to 2021 to 83,536 tonnes while green tea output should shrink 2.5% to 25,619 tonnes over the same decade, according to the FAO. Still, Indonesia’s substantial tea industry afforded it a seat at the table as a founding member of the International Tea Producers Forum in Sri Lanka in January 2013.

OUTLOOK: An integral part of the social and economic fabric, the agricultural sector will continue to play a key role in the economy even as it continues to transform into an industry with a more value-added downstream-oriented focus. Policies restricting the export of raw materials – particularly in the cocoa and palm oil sectors – should stimulate investment into the sector. Although this has led to some growing pains for exporters in the short term, rapidly expanding processing capacities should provide ample room for growth of the downstream sector. How these diversification strategies interact with food security goals and associated potential tax and non-tariff barriers will determine the business climate ahead for agribusinesses.