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Draft October 31, 2009
The Roles of Private Sector in Indonesia’s Rice Industry
Bustanul Arifin
Research Report prepared for the World Bank, Washington, DC.
_____________________
Bustanul Arifin is professor of agricultural economics at the University of Lampung,
professorial fellow at the International Center for Applied Finance and Economics in
Bogor Agricultural University (InterCAFE-IPB) and senior economist with the Institute
for Development of Economics and Finance (INDEF) in Jakarta, Indonesia. The author
could be reached at his email [email protected] and cell-phone +62-812-940-1150.
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1. Introduction: Structure of rice industry in Indonesia
The rice industry in Indonesia is definitely the largest industry in the country,
employing more than 12 million people in the rice farming and other related small and
medium enterprises (SMEs) in rural areas. There is no other industry that as big as the
rice industry, counting the upstream in the farm and downstream in rice milling. In
addition, the rice industry is very political where all political leaders in Indonesia, from
President Soekarno, President Soeharto, to the current President Susilo Bambang
Yudhoyono have used the approach of food security in the political and economic
development strategies. Consequently, the economic decision in running rice industry
often intersects with political decision or government intervention. The society at large
keeps open eyes very closely and put a very high expectation on the success of any
government programs related to rice industry or food security for the country.
The development of rice industry in Indonesia cannot be separated from the rise
and fall of agricultural sector in general. Agriculture has experienced a rapid growth
since the early 1970s up to mid 1980s, partly as a result of expansion in resource
endowments and increased yield in rice as a main staple foods, brought about by
advances in production technology. A tremendous increase in the level of intensive land-
use system is also associated with the spread use of new seed varieties and chemical
fertilizer. Indonesia experienced a successful self-sufficient level in rice production in
mid 1980s. However, this high growth rate was not sustained in the 1990s due to several
reasons associated with non-conducive policy environments, low pace in research and
technological progress and agribusiness systems.
The rice production has experienced a significant decline in the early 1990s,
mostly due to droughts in 1987/88 and 1992/1993 and pest incidents in major production
centers. More importantly, deterioration of important infrastructures such as irrigation,
roads, bridges, ports, etc, in several places of the country has contributed to the decline in
agricultural growth. As the research system and technological progress failed to improve
the rice yield required to maintain the necessary growth rates and when public
expenditures on these important elements of agricultural development declined
significantly in the 1990s, the performance of Indonesian agriculture suffered. The
slowdown in growth or leveling-off in agricultural production has continued until the
early period of the 1998 Asian Economic Crisis and the fall of President Soeharto,
marking more complex settings of transitional period of economic and political reforms.
During that difficult time, rice industry was really a focus of attention because
Indonesia experienced a very serious production decline due to long drought as a result of
El-Nino season. Consequently, Indonesia has to depend on a very large amount of rice
import just to fulfill the domestic consumption. The price of rice skyrocketed to a level
which was not affordable by the poor, let alone the impact of declining purchasing power
due to imported inflation. Even though, Indonesia imported a record high of 5.8 million
ton in 1998, the price of rice remained very high, which also contributing to inflation rate
in the following year. The wet season of La-Nina year in 1999 contributed further to bad
performance of rice production, resulting in another import surge of 4.2 million ton.
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Within two years of 1998 and 1999, rice import reached to 85 and 78 percent above the 3
years moving average, the record high in the modern history of rice industry in Indonesia.
A similar story of rice import surge occurred again during extreme weather
condition of El-Nino drought and La-Nina wet season in 2002 and 2003, where Indonesia
has to import respectively 3.1 and 2 million ton. The magnitude of how strong the
political dimension of the economy of rice industry in Indonesia could be seen from a
very high attention of every level of society on the performance of rice production, price
stability, and stock management. A common belief is that the import surge of rice in
Indonesia is closely related with a significant decline in domestic price of non-husked
rice at farm level and decrease in the flows and volumes of inter-regional and inter-island
trade of rice in Indonesia. Moreover, the import surge had affected directly the
rice/paddy industry, includes are the farmers, paddy millers, traders, harvesting and post-
harvesting labors. It had also affected the seed, fertilizer, pesticides and agriculture
machinery and equipment industries (Sawit and Lokollo, 2007).
During the economic and political transition after Reformasi, rice industry has
faced a very serious instability episode, especially in relation to price stability, stock
management, and uncertain investment climate in the country. Immature trade
liberalization policy enforced by the International Monetary Fund (IMF) has created
instability both in paddy price and rice price at consumer level. In addition, the policy
to reconstruct the agricultural sector could not be translated into concrete actions at the
regional and field level. The government has tried to develop a model of corporate farms
as a means to integrate a more modernized decision making process. However, because
of the weakness in theoretical and policy foundation in such a concept, corporate farm
model was rejected by the society. Notwithstanding, because of the financial crisis and
more funds were allocated for restructure the banking industry, the government was
failed to allocate the budgets for public infrastructures, especially irrigation systems,
research and extension expenditures. Consequently, agricultural sector could not
achieve a minimum level of 2 percent growth, which was required to maintain
subsistence level of the society, primarily because of low performance in food crops and
cash crops (Arifin, 2007).
Over a decade after the Asian Economic Crisis, or when the global economy
experienced financial crisis in 2008, inquiries over the structure of rice industry in
Indonesia are very relevant to bring into a more thorough and deeper examination. In the
last decade after the Reformasi, Indonesia has issued several policies affecting the growth
and performance of rice industry. The current administration under President Yudhoyono
issued a well-known policy strategy on ―revitalizing agriculture‖ in 2005, although there
has been no significant indication at the field level that could lead to radical changes in
the structure of rice industry. Rice production system which is highly dependent on
small-scale rice farmers implies serious complexities related to increasing economies of
scale and efficiency level. According to the newest farm household data published by
Central Agency of Statistics (BPS) in July 2009, in the upstream sector, rice industry has
to rely on 9.5 million farm households with 0.5 hectare of land or 53.6 percent out of total
17.8 million farm households. In the downstream sector, rice milling and processing
industries also rely on 132 small-scale millers affiliated with Perum Bulog, a state-owned
enterprise having responsible for rice price stabilization rice subsidy for the poor, and
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some large scale private sector millers. These farmers cultivate rice fields in the most
fertile lands and in the regions with the best water-control and access to large domestic
and global markets.
Rice in Indonesia is produced in 11 rice production centers, namely: Aceh, North
Sumatra, West Sumatra, South Sumatra, Lampung, West Java, Central Java, East Java,
Bali, West Nusa Tenggara, and South Sulawesi. Nearly 60 percent of rice production in
Indonesia comes from Java and Bali, islands with large urban populations and well-
developed market infrastructure. If there is no significant progress in arable land in Java,
which is very likely so, then Indonesia would face serious challenges in meeting the
growing demand of rice. Relying the rice production on increasing cropping intensity,
rather than progressive technological change is clearly not the answer for a huge
challenge of food security in the future. The fact that the slow growth in production
results mainly from a slow expansion in land area and declining yields presents a threat
for the government program of revitalizing agriculture.
Table 1. Rice Production, Harvested Area and Productivity, 2002-2009
Year Harvest Area
(Ha)
Productivity
(ton/ha)
Production
(Ton)
Growth
(%)
2002 11.521.166 4,47 51.489.694 2,04
2003 11.488.034 4,54 52.137.604 1,26
2004 11.922.974 4,54 54.088.468 3,74
2005 11.839.060 4,57 54.151.097 0,12
2006 11.786.430 4,62 54.454.937 0,56
2007 12.147.637 4,71 57.157.435 4,76
2008 12.343.617 4,88 60.279.897 5,46
2009* 12.668.989 4.94 62.561.146 3.71
Notes: *) The third forecast, July 2009
Source: Central Agency of Statistics (BPS), various issues
During the current global financial and food crisis, an increase of rice production
and the ability of Indonesia in stabilizing rice price at consumer level in the last three
years might relax the pressures of price rise due to instability of rice supply in the world
market. Rice production this year (2009) is estimated to reach 62.6 million metric ton of
dry un-husked rice or equivalent to 37.6 million ton of rice (BPS, 2009). Many analysts
suggest this is an over estimate because it does not consider the potential production
decrease due to drought in some parts of Java and Sumatra and persistent inefficiency in
harvest and post-harvest. As production data remain controversial over the decades,
more credible estimates have to be conducted using better methods of calibration, from
farm level to rice milling and processing industries. Due to stagnation in infrastructure
development and rehabilitation during the current administration, the source of growth of
rice production has to rely on increasing cropping intensity or harvested area (2.8%),
instead of yield increase (0.9%). During El-Nino year, rice production usually declines,
because the drought has reduced both cropping intensity and the yield.
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One should note that the conversion rate from non-husked rice to the rice ready
for consumption rice, known as milling ratio, has declined significantly since the last two
decades. Rice processors are facing serious problems of low efficiency and high losses,
due to among others, low investment in rice processing industry, ageing machinery in
both private and government-owned rice milling unit. The conversion factor commonly
used in the literature is 0.63 for the data after 1990 and 0.65 before the 1990, although the
new estimate has been introduced due to the declining efficiency and increasing losses in
the processing industry. The declining average milling ratio in commercial rice mills is
due to the increasing number of ageing machines (which use the single-pass system), and
to the tendency of ―mobile operations‖ with small-scale units. The low industry average
milling ratio indicates technical inefficiency in the industry, although its economic
efficiency may actually not be low. The latest estimate of conversion rate from non-
husked rice to milled rice ready to consume is 0.5663, a significant decline from a
conversion rate of 0.65 normally used in the 1980s (Kaman Nainggolan, 2009, personal
conversation). This is another reason to question the official estimate of food balance,
especially between rice production and consumption, which usually becomes the major
criteria to determine rice import in the country.
Moreover, rice industry is clearly more than just foodstuffs. The issues of food
security spans from the availability of rice at household level, accessibility by the poor,
price stability by region and overtime, and utilization of good practice, diet, hygiene,
halal food. Rice production creates social benefits for the public from the lowest level of
society of political leaders of the country. The role of non-food services of rice includes
the following (see Dillon et al, 1999): (a) political stability: inadequate supplies of
domestic rice at an affordable price causing consumers tend to panic, sometimes leading
to social riots; (b) environmental and cultural preservation: irrigated rice-field paddy
production contributes to soil fertility, prevention of urban flooding, biodiversity
conservation, local and cultural wisdom; (c) public health: irrigated rice production
generates rural ambient cooling and involves continuous village water flow, reducing
morbidity risk and rural sanitation; (d) employment generation: significant amount of
rural labor absorption discourages excessive permanent rural-urban migration; (e)
income-distribution: labor intensive rice production raises rural incomes and reduces
rural poverty and unequal income distribution; (f) labor-market competitiveness: rice is
the principle wage-good for unskilled labor, which inspires labor-intensive activities of
non-rice industries; and (g) economic stability: adequate rice supplies contribute to
price stability and improve the domestic investment climate.
Another important grain in Indonesian is corn, which has been known as a
secondary food crop and feed sources for livestock development. Corn production is
expected to increase to 16.32 million ton in 2009, primarily due to increased in harvested
areas in East Java, Lampung, Central Java, North Sumatra, South Sulawesi, Gorontalo,
East Nusa Tenggara and West Sumatra. An increase of 3 million ton (22.8 percent) is
brought about by increasing use of hybrid seed, and other results of (traditional)
biotechnology. Indonesia is now in preparation to increase the use of (modern)
biotechnology where genetically modified organism has been in forefront public debates
and high-level discussion. Increasing corn production also has positive impacts on
poultry and livestock sectors, where feed industry has developed significantly in the last
decades or so. Small-scale meat producers do not have to rely on imported feed, which
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experience significant price increase, especially during the global crisis. One could
expect that the role of private sector in corn-related industry is much more significant, at
least in the last two decades, since feed mill industries have actively contributed to the
livestock development. Livestock production in Indonesia is stimulated by the fast
growing demand for livestock products, at least during the first wave of high economic
growth in the 1980s. This high growing rate of livestock development is usually known
as Livestock Revolution.
Generally, studies about the structure of rice industry in Indonesia suggest that the
market structure is generally not competitive, ranging from oligopsony at the farmers‘
level, to oligopoly at traders‘ level, and monopolistic at consumers‘ level (KPPU, 2009).
The usual problems of large number of rice farmers dealing with few collector traders at
village level have contributed to the price formation at the farm level, which usually in
favors of collector traders and village or sub-district of larger traders. When rice farmers
are not free in making choice of buyers, due to economic-based relationship and societal-
based dependency between farmers and collector traders, the market structure fits into a
category of oligopsony. Transaction between few numbers of large-scale rice-milling
unit or inter-island traders and large-scale of wholesale markets at the provincial level
tend to form a structure of oligopsony or oligopoly because they are really in transition
between traditional farm level or rural area and modern rice traders and highly
sophisticated wholesalers at urban centers. These traders generally have partners with
rice retailers at the traditional market place and modern supermarkets. A monopolistic
market structure is usually found at the retail market, not only because the number of rice
retailers are very few, who sell to a large number of consumers with very limited
information about the rice quality.
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2. Private sector involvement in rice industry
Private sector involvement in rice industry in Indonesia is as old as the trading
and processing activities and far more dominant than the state involvement. The
government intervention in rice trading in Indonesia has started in the late 1960s, when
Indonesia faced serious threat in food security and in economic recession. Economic
actors of rice trading generally consist of collector traders, rice milling units, wholesalers,
bazaar traders, and retailers. The business scale of these actors varies from a household
level, small-scale trader, up to a level of conglomerate who controls rice-milling units,
wholesalers, Bazaar traders and retailers. Consequently, the level of business, market
share and marketing power and access to market information, sources of capital and
government policies varies significantly. Most of these traders have been involved
directly and indirectly with the government policies on price stabilization and rice
distribution and marketing system. These actors may have dealt both directly and
indirectly with a larger number of producers or rice farmers under special patterns of
transaction. Only few of the actors, especially rice milling units and wholesaler traders,
have a direct access to retail market of rice, thus with a larger number of rice consumers.
Actors with limited market and information access generally could not
accumulate a large amount of capitals. The scale of business remains small ever since.
The opposite phenomena are found in the larger scale of business of rice trade. The
existing larger scale of rice milling units and wholesalers started the business at a
household level in the 1970s and 1980s. Few of them involve with the government
policies on rice procurement and import activities through special arrangements with
Bulog. These businesses developed very rapidly in the 1990s, in accords with a
tremendous increase in rice consumption in the country. Economic profits being
obtained from rice trade even contribute to the development and the path of the business
and could generate new investment for increasing the economic of scale. However,
during the Asian Economic Crisis, both small-scale business and large-scale business
have experienced a significant decline in business turnover and economic gains. Since
1999, Indonesia has passed and implemented Law 5/1999 on fair competition and anti-
monopoly and establishment the Commission responsible to supervise the competition.
In the last decade of economic recovery process, supermarkets and fast food
chains has emerged very rapidly, contributing to the new paths for vertical arrangement
between agriculture and its allied industries. The process of vertical arrangement can be
visualized using the value chain that exists in Indonesia‘s food markets. Since direct
coordination between farmers and supermarkets either through ownership or through
contract can reduce information asymmetries that otherwise prevails between urban
consumers and rural producers, coordination is a way to meet the changed demand. Since
coordination can also reduce the need on behalf of farmers to search for market
transactions and associated costs, it is also a way to reduce transaction costs. In addition,
this type of arrangement can also induce commercialization and specialization at farm
level and diversification at national level. In fact one can argue that the changing patterns
of consumption and forms of retail may have mutually reinforced one another. On the
one hand, clearly changing consumption patterns in favor of high value foods demand
different forms of retail, and supermarkets have arisen to fill this demand. On the other
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hand, the emergence of supermarkets has increased the widespread availability of high
value foods and increased the consumption of high value foods further.
Competition in the supermarket sector has been driven by the expansion of
existing operators and the entry of new foreign operators. Department stores have also
moved into the supermarket trade. Mini-markets and new discount retail formats (for
example, Makro, Alfa, SuperIndo) have arisen and they are attracting lower to middle-
income consumers away from supermarkets. The establishment of large one-stop
shopping centers and the continuing development of the food service sector are also
affecting the pattern of modern Indonesian retailing. The process connecting production
activities and consumption is either the centralistic system or decentralistic. Centralistic
system refers to marketing for rice in Indonesia was centralized in the wholesalers or
Bazaar trdaers. The main function is to stabilize price by signiling at several marketing
institutions, namely for producer and consumers. This system has three main stages:
collecting, standardization and grading, which all determine the quality of rice being
traded. The centralistic system has now changed to a more decentralized pattern of
trading, and involved other marketing institutions such as village, sub district or district
collector and rice milling unit (or the miller).
The following sections explain the price sector involvement in rice industry in
Indonesia, covering: (a) rice production process involving mostly small farmers; (b) rice
trading involving two major marketing channels: private and government-related; (c) rice
processing involving small scale millers and large scale companies and rice-flour
industry, and (d) rice storage or stock management for buffering, prize stabilization, and
emergency actions.
(a) Rice Production
As briefly mentioned in the previous section, rice production in Indonesia relies
on small scale farmers or economic actors, with limited access to financial sector,
technology, and markets. The newly published data by BPS suggests that the total
number of farmers in 2009 is estimated as 9.5 million farm households with land holding
0.5 hectare of land less, or more than 53.6 percent out of total 17.8 million farm
households in Indonesia. Moreover, rice production system has also face the challenge of
uneven land-use structure and land distribution, both within the province and between
provinces or particularly between Java and Off-Java. The number of agricultural
households in Java increased from around 11.7 million in 1993 to 13.6 million in 2003.
The figure for the whole Indonesia during the same time period increased from 20.8
million to 24.9 million, suggesting the addition of more than four million households
entering the agricultural sector during a decade—an average of around 400 thousand new
entrants per year.
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Table 2. Number of Agricultural Households in Indonesia, 1993 and 2003
Items
Number of
Agricultural
Household (000)
Agric Household
Utilizing their
Land (000)
Agric Household
Controlling Land
<0.5 ha (000)
Agricultural Census 1993
- Java 11,671 11,564 8,067
100% 99% 69%
- Off Java 9,116 8,954 2,737
100% 98% 30%
Indonesia 20,787 20,518 10,804
100% 99% 52%
Agricultural Census 2003
- Java 13,583 13,262 9,842
100% 98% 72%
- Off Java 11,286 10,799 3,411
100% 96% 30%
Indonesia 24,869 24,061 13,253
100% 97% 53%
Source: Agricultural Census of BPS, 1993 and 2003
It seems likely that agricultural land extension grows less rapidly than the number
of farm households. As a result, land fragmentation increases. In Java, households with
agricultural land of less than 0.5 ha increased from 69 percent in 1993 to 72 percent in
2003. This brings about an increase in the number of households with agricultural land of
less than 0.5 ha through out Indonesia to 53 percent in 2003. Increasing number of small
farmers suggest that agricultural production practices in the future would be more
complex. In addition, throughout Indonesia, around 75 percent of agricultural households
own and operate their farm of the size less than a hectare. That with the size of 1.0-2.0 ha
consists of approximately 15 percent, and above that is around 10 percent. With most of
the agricultural land ownership below 1.0 ha (and around 53 percent is below 0.5 ha), it is
quite difficult for farmers to attain economic scale, unless the farming activities are
functionally consolidated (see Siregar, 2007). Policies of agrarian reforms announced by
President Yudhoyono during the Political Speech of New Year in January 31, 2007
should be implemented soon, in order to slower –even to offset – the increasing rate of
agricultural households controlling the land 0.5 hectare or less.
The legislation controlling the land ownership and land control actually has been
in effect since the 1960s. Law 5/1960 on the Basic Agrarian Law and Government
Regulation 224/1961 stated that the maximum area of land control for upland is 20
hectares, and for lowland is 12 hectares. In additions, land control for houselot in
residential area is 5 parcels, with the maximum of 2000 square meters on each parcel.
Unfortunately, these institutional arrangements have been very difficult to enforce so that
it is very common that individuals or corporations control the land extensive amounts of
agricultural land, up to millions of hectares, especially outside Java.
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The Yudhoyono administration tries to simplify agrarian reform policies, focusing
on two actions: namely (1) asset reforms by redistributing the land to the poor farmers,
and (2) access reforms, by improving farmers‘ access to new technology, infrastructure
and market information. About 9.25 million hectares (8.15 million hectares in Java and
1.1 million hectares Off-Java) are potentially available for agrarian reform. These lands
are mostly former conversion forests, which should be converted into agricultural uses,
the state-owned land previously controlled by large corporate farms or plantations where
the permit are not being extended, and other categories of state-owned land. The spirit of
the agrarian reform is not only to control land holding, but also to contribute to poverty
alleviation and to improve farmers‘ access to technology and market information, hence
contributing to the development strategy of revitalizing agriculture. Unfortunately, only
little progress has been achieved by this agrarian reform programs and policies.
(b) Rice Trading
Generally, rice trading patterns in Indonesia do not differ significantly by regions.
Rice trading could be seen as one step of the overall rice marketing, that is the process
for distributing the rice from producers to final consumers. Some marketing institutions
involved in rice trading are collectors (village, subdistrict and district), wholesalers,
Bazaar traders, retailers and final consumers. Other institutios involved are rural
cooperatives (KUD), millers, Bulog, importers and urban markets in general (see also
Arifin et al., 2001, Arifin at al., 2006, Sawit and Lokollo, 2007, Firdaus et al., 2008).
The general pattern of rice trading in Indonesia can be grouped as follows:
Generalized Private Channel
First Pattern: Farmers –Collector Traders–Wholesalers (Rice Millers)–Bazaar Traders–
Retailers–Consumers.
Second Pattern: Farmers–Collector Traders–Rice Millers–KUD–Bulog–Urban Markets
Government-Related Channel
Third Pattern: Farmers–Farmers‘ Group–KUD (Rice Millers)–Bulog–Bazaar Traders–
Retailers–Consumers.
Fourth Pattern: Farmers–Farmers‘ Group–KUD (Rice Millers)–Bulog–Urban Markets.
The first pattern is pure private channel, and the fourth pattern is pure government
channel. Whereas the second and third are marketing channel involving interaction
between the private and government channel. The magnitude is much dependent on the
level of village cooperatives activity in doing business with the government institutions.
Actors involved in the rice trading can be summarized as follows:
1. Farmer (Producer): Farmers are rice producers who conduct farming activity for
agricultural investment, especially in rice farming. Farmer is a manager of
production factors who makes a combination decision of land resources (rent, own or
sharecrop), labor (family and non-family), capital (fixed and current) and managerial
skill. Farm-management should be market oriented, even though not all rice farmers
in Indonesia can perform such as a way of doing farm business. Some farmers operate
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only at a subsistence level, where rice products are mostly used for the household
consumption. Others sell the rice to a broker-trader (locally known as tengkulak) or
collector-trader before or after the harvest. Most farmers today have rational decision
to plant the rice, not only as a response of price signal and income earnings, but also
as a food security purpose and a way of life in agricultural sector or cultural decision,
viewing rice as the most important and invaluable food in the human life.
2. Collector Traders: Collector traders do buying dry paddy from farmers in the form
of wet and non-husked grain (GKP) or dry and non-husked grain (GKG). Traders
also do processing by operating a business on rice milling unit (RMU) either own by
himself or other person. Paddy collectors can be classified by operation area, namely
village collector, sub district and district collector. The village collector obtain the
paddy from the farmers and then doing the marketing function activity such as
processing from paddy to the rice and selling it to the sub-district collector or district
collector. In some region, collector trader is supplying rice to Bulog office at district
level (sub regional division) by through rural cooperatives or Koperasi Unit Desa
(KUD) and other contractors. Collector traders also sell the paddy through the miller
or rice milling unit (RMU) in sub-district and district. District collector generally
sells the rice to other regions with no or limited number of rice milling unit.
3. Rice Milling Unit (RMU): The processing industry or rice milling unit functioned as
services in the milling or hulling paddy either from the farmers or other collector
trader. In some cases, the owner of millers is as collector traders. In addition to
serving as commodity receiver from the farmer, they also do an activity as a miller.
They obtain additional value of rice from the trading activities and from milling the
paddy into the form of rice. The milling activity is a marketing function performed
by a person or a company for serving the trader (tengkulak), collector or individual
farmers. Generally, there is no contract agreement (contract relationship) from one
person to another. A collector trader (tengkulak or penguyang) has a freedom to
choose any rice-milling unit available in the region. A miller owner could serve the
farmers directly for the milling services, but also buy a paddy to be milled and sold in
the form of rice. The characteristics differentiate between the owner of rice milling
unit and the miller traders are in terms of scale and volume of business. Generally, the
owner of miller uses the mill machine with relatively small capacity and the finishing
process is still needed through refining phase. The miller also acts as a trader to buy
rice grain directly from the farmer, especially during the harvest season. They collect
the harvest distributed in some areas (villages) in certain place (location). Increasing
quantity and the quality of infrastructures available causes the role of the smaller rice-
milling unit in rural area become more important. These are the marketing actors
very closed to production location and have ability to perform marketing function,
even though in a very limited role. Therefore, collecting, processing, transporting and
expected profit margin would determine the marketing margin obtained by the
collector trader as well as a rice-milling unit.
4. Wholesalers and Bazaar Traders: Wholesalers and Bazaar traders are the traders
who sell their rice in the big volume. This can be personal trader or firm that doing
their business by buying rice and then sell their product to the retailer or direct
consumers (end user). To get their supply, Bazaar traders usually obtained their rice
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from the miller trader (in the medium classified). The Bazaar traders generally stay in
the central of town either in the district of area or provincial area. These traders are
operating in big cities or capitals of province in Indonesia, although the main ports of
trading rely on few cities: Medan and Bandar Lampung in Sumatra, Jakarta and
Surabaya in Java, Makassar and Manado in Sulawesi. In greater Jakarta region, these
traders can be found in the main market pace in the Jakarta Food Station (JFS) at
Cipinang, Jakarta. The big trader generally has a marketing network in the region and
outside the region (inter-island). These Bazaar traders receive the supply of rice from
collector trader (certain case if there is a market operation by Provincial Office or
Regional Division of Bulog). Some large-scale traders having the stores in JFS also
serve as rice importer, and not only trade the rice in a particular region, but also sell
the rice in different region or serve as an inter-island trader. Some traders serve as a
broker, who operates on a commission fee basis, especially in connecting big cities
and smaller towns in the vicinity.
5. Retailers: Retailers refer to traders who get the rice in a big volume, and sell the rice
in small volume to final consumers. The main function is to separate product in the
small scale. In the rice business, generally there is no entry barrier found since the
number of trader is much enough compared to another class (wholesaler, collector
and Bazaar traders). The retailer sells the rice in the small amount in kilograms or in
liters. The trader generally not only specifies their products in one brand, but also
inter-connected with the other brand and mainly staple food (corn, soybean, peanut).
Generally, the retailer obtain their supply of rice from the Bazaar traders, collector
and miller trader. The rice volume traded by retailer approximately from 50 kg up to
500 kg per day. Retailers usually spread from private stores to supermarkets in the
city (urban area) to small kiosks in small towns villages (rural area). Generally the
retailers serve as the final marketing agents, where final consumers do the transaction,
usually in cash, to buy the rice. Some large-scale traders sell either household or non
household consumers such food restaurants, companies, and state-own enterprises.
6. Rural Cooperatives (KUD): The rural cooperatives (KUD) and other similar rural-
based institutions are economic institutions having business activity in rural area,
especially in agricultural sector. The cooperatives play important roles in the national
rice procurement program, fulfill the buffer stock of rice and government stock of rice
(CBP=cadangan beras pemerintah) managed by Bulog and simply serve as Bulog
contractors to procure the rice for other purposes. The cooperatives spread all over
the country from rural to urban area and used to be important and significant
institutions during Soeharto administration or pre-reformed New Order. The
cooperatives usually have a direct link with farmers‘ group or associations of farmers‘
groups, not only serving to buy the farmer‘s products, but also selling agricultural
inputs to the farmers. Even though their roles are not as big as the private sector,
KUD has an important and significant role in receiving the agricultural product of
farmers and then distribute the paddy thorough provincial or district office of Bulog.
The current government administration has special program to revitalize agricultural
cooperatives and farmers‘ groups and develop the so-called rural economic institution
program (LUEP= Lembaga Usaha Ekonomi Pedesaan). If the stock of non-husked
rice (gabah) in the region is low, rural cooperatives would buy non-husked rice form
other regions, especially the production centers. The problem faced by rural
12
cooperatives in rice procurement is the limitation of capital and financial resources,
including the government programs such as, food security credit (KKP=Kredit
Ketahanan Pangan), small-scale credit (KUR=Kredit Usaha Rakyat), and LUEP.
7. Bulog: Bulog as a state-owned enterprise with a special mandate as logistic agency
to stabilize rice price and to implement subsidized rice policy to the poor under the
Raskin Program. Bulog was previously a government agency responsible for floor
price policy and ceiling price policy, which became an important element of the
history of rice policy and food security in Indonesia. Since 2003 Bulog has officially
changed into an enterprise with similar mandate, but more on implementation aspects
of food security policy. Bulog plays important roles in rice trade, serving as a buyer
from collector traders to procure the buffer stock and government stock of rice, and as
a seller to traders especially in special market operation and a ―distributor‖ in the rice
for poor (Raskin) program.
(c) Rice Processing
Rice processing industry in Indonesia is actually quite simple. It transforms the
form of paddy or non-husked rice into rice grain by performing milling activities. Some
activities involving rice processing also transforms the rice grain into rice flour and sells
freely in the market. Current challenges of rice processing industries or food processors
in general is in linking farmers to domestic and international consumers include how to
manage properly its dual structure. Whereas, small-scale producers, processors and
distributors operate under a traditional style of management, large-scale companies adopt
modern management and high-tech applications. In the first group, the small farmers
sometimes face asymmetric market information and oligopsonistic market structure, at
the farm-gate level. As explained previously, before reaching processors, rice and other
agricultural products have to go through trader-collectors in the villages. These traders
usually come from medium-income group of the villagers, own quite considerable
amounts of assets, and trade more than one agricultural commodity.
It is very normal for these village level collectors to have ―special‖ arrangements
with small farmers in the form of 50/50 revenue sharing or payment arrangements for
agricultural products. The arrangements could be in the form of loan for the purpose of
advanced capital and in the form of cash money for subsistence purposes and daily needs.
Village collectors who have been able to establish relationships with small farmers
generally have more power to determine the farm-gate price of bulks of agricultural
products. Consequently, small farmers sometimes do not have a freedom to choose the
village level collectors to work with, even though the opportunities are widely open. In
other words, farm-gate price setting is not really determined under an open market
competition, but rather using non-economic instruments such as psychological
dependency between farmers and traders-collectors. These collectors and traders bring
agricultural commodities to processors or factories that transform them into higher added
value products. The rice milling unit or processors serve as important players in the rice
supply chain, especially the efficiency level in the process of transformation from paddy
to rice would determine the real volume of rice, ready to consume.
13
The data from Indonesian Rice Millers Association (Perpadi) suggest that the total
number of large-scale millers is 5.133 units with the total capacity of 2.2 million ton (5.5
percent of the total); small-scale rice millers nearly 40 thousand units with the total
capacity of 22 million ton; and rice milling units (RMU) 35 thousand units with the total
capacity of 14 million ton. The RMU is generally managed by individuals and rural
cooperatives; which serve directly the farmers both for own consumption and for quick
selling for cash purposes. It is estimated that these rice millers and RMU are only
operated in their 60 percent capacity, primarily because of seasonal problems of rice
production. If the country experiences a surge of rice import, during the period before
2007, then these rice millers operate well-below their capacity (Sawit and Lokollo, 2007).
Unfortunately, rice processors are facing the perennial problems of low efficiency
and high loss during harvest and post-harvest. A study by Maksum (2002, cited in
Simatupang and Timmer, 2008) suggests that the total loss of during harvest and post
harvests of rice in Indonesia is about 20 percent, a quite large number for a country
facing serious food security challenge. This inefficiency figure relatively has not changed
for more than two decades, implying a very serious constrain and poor access on harvest
and post harvest technology. The highest component of the losses is in harvesting
(9.6%), followed by threshing (4.8%), milling (2.7%), drying (2.2%), storage (1.1%) and
transporting (0.3%). The programs on agricultural mechanization and modern rice
milling development since the 1980s should have contributed to the contributed to the
reduction in milling losses. The rate of new investment and maintenance of old machine
and equipments might be not as fast as that was required by the pace to develop
efficiency standards in the industry.
Table 3. Development of Paddy–Rice Milling Ratio, 1949–2004
No. Crop Season Location Milling Ratio (%)
1 1949 Java, Madura 69.0
2 1950 Java, Madura 71.2
3 1974 Java 64.6 – 65.1
4 1979 West Java, East Java, Bali, South Sulawesi 64.8
5 1981 East Java 66.3
6 1982/1983 8 provinces 64.6
7 1985 15 provinces 65.9
8 1994/1995 15 provinces 63.2
9 1997/1998 West Java (District Karawang and Subang) 62.0
10 2002 East Java 62.0
11 2004 6 provinces 59.0
Sources: Simatupang and Timmer (2008)
14
Simatupang and Timmer (2008) also suggest that the size of the harvesting loss is
determined primarily by the system of labor organization. There are three main systems
in rice farming: open access (bawon/ keroyokan), tied-contract (ceblokan) and trader–
harvester (tebasan). Losses during threshing are determined mainly by the technology
used. In Indonesia, paddy threshing is conducted either by slapping (banting) or using
mechanical equipment (powered or manually operated). The choice of threshing system
is closely related to the harvesting labor system used. Open-access and ceblokan
harvesting systems are generally associated with banting threshing, whereas trader–
harvester systems are associated with mechanical threshers. The largest loss occurs with
open-access harvesting and the slapping threshing system (18.6%), and the lowest occurs
with labor-group (or trader–harvester) harvesting and mechanical threshing (5.9%). A
method of banting threshing remains the most widely practiced form of rice threshing in
Indonesia, and therefore losses remain high. Indonesia has to promote ‗managed
harvesting‘ – aiming not only to improve social capital in the village, but also to utilize
labor groups and mechanical threshing, which would reduce the harvest losses.
Some farmers have equipments, but most others do not have access to a simple
harvest tools such as power threshers and rice driers. Drying the paddy under the sun is
very common in the rural area of production center in the country. Therefore, the
potential and actual loss during harvest and post-harvest are also high at the farm level
and processor level. For example, a study by Arifin et al (2001) suggests that the
utilization of power thresher technology could reduce the farmers‘ loss up to Rp 67
billions or equal to 304.5 ton per season in a district of Karawang in West Java, one of
the major rice production center in Indonesia.
(d) Rice Storage
Rice storage in Indonesia is conducted by private traders, households or
community storage and government-owned enterprise Bulog. More than 90 percent of
rice storage is implemented by private traders and community, while Bulog is able to
store rice about 2 million ton or about 7 percent of the total rice production in Indonesia.
There has been no clear pattern of how the total amount of rice storage is related to rice
production, even though in recent years, the total storage is positively correlated with rice
production. In 2005, the total rice procurement conducted by Bulog was 2.1 million ton
or about 6.14 percent of 34.2 million of rice production. Then, for three years in row of
2005-2007, the total rice procurement was far only 1.6 ton per year, although rice
production increased steadily. Since the declining rice production has become a strategic
issue and rice producing countries intend to secure their domestic stocks, Bulog was also
pressured to increase the total amount of rice procurement, especially from domestic
sources. In 2008, Bulog was able to procure rice as much as 3.2 million ton or 8.42
percent of total rice production in their storage warehouses, and expected to increase to
3.8 million ton or 9.87 percent of total rice production.
As mentioned previously, Bulog has two main mandates: to stabilize rice price
and to distribute subsidized rice for the poor. To implement these mandates, Bulog is
15
supported by 26 regional offices at provincial level and 105 sub-regional offices at
district level; and employing 5,052 personnel. Bulog is assigned to purchase the rice
produced by farmers at the procurement price set by the government or the Presidential
Decree, updated each year or two. When the rice price increase abnormally, due to for
example low production in domestic market, Bulog has to implement ―market operation‖
in the urban areas in Indonesia. Bulog has 1,575 units of warehouses with the total
capacity of storage is 3.96 million metric ton. Among the largest are the storage
warehouses in Jakarta, covering the total of 370 thousand ton, in Surabaya of 333
thousand ton, in Makassar of 199.4 thousand ton, in Medan 99 of thousand ton and in
Dumai 14.5 thousand ton. In additions, Bulog has 132 units of paddy processing
facilities or rice milling units (UPGB=Unit Pengolahan Gabah dan Beras). In additions,
Bulog has also 42 units of drying center, and 50 thousands rice distribution points for
―rice for the poor‖ or Raskin Program, which spreads all over the country. In 2008,
Bulog has delivered 3.2 million ton of rice to 19.1 million poor households. The total
ration of subsidized rice is now reduced to 15 kilogram from previously 20 kilograms per
poor household per month, in order to increase the coverage. In 2009, the subsidized
price of rice for the poor is Rp 1,600/kg or approximately 35 percent of the normal price
of rice in the domestic market. The total budget for subsidized rice for the poor in 2008
was Rp 11.7 trillion (US$ 1.2 billion), which was 0.3 percent of total Gross Domestic
Product (GDP) in that year. This amount is nearly double from the total amount of
subsidy allocated for rice for the poor program in 2007. The global food crisis is really a
significant pressure to increase budget allocation for the food subsidy and the strategy to
maintain food security in the country.
Table 4. Rice Quality Traded According to Indonesian Industry Standard (SNI)
No. Components of Quality Unit Quality
III PLUS
Quality
III
Quality
IV
1. Degree of maturity (Min) (%) 100 95 95
2. Water content (Max) (%) 14 14 14
3. Head rice (Min) (%) 87 84 78
4. Wholesome grain (Min) (%) 44 40 35
5. Broken grain (Max) (%) 10 15 20
6. Small grain (menir) (Max) (%) 1 1 2
7. Red grain (Max) (%) 1 1 3
8. Yellow grain (damaged) (Max) (%) 1 1 3
9. Limed grain (mengapur) (Max) (%) 1 1 3
10. Foreign object (Max) (%) 0.02 0.02 0.02
11. Non-husked grain (Max) Grain/100gr 1 1 1
12. Mixed with other variety (Max) (%) 5 5 5
Source: Bulog, 2009
16
The rice procurement and rice storage managed by Bulog has to follow certain
criteria according to the Indonesian National Standards (SNI=Standar Nasional
Indonesia). This covers among others degree of maturity, water content, head rise, broken
grain, small grain, yellow grain, etc (Table 4). These standards shall comply with the
storage requirements that could meet the technical and economic efficiency arguments in
the rice industry. The requirements are also used as a basis to formulate a periodic
presidential decree on rice policy, covering the production, trade, procurement price,
diversification, etc.
Obviously, the storage requirements outlined in the Table 4 are really not easy to
meet, especially by small farmers. As a result, the rice quality stored by Bulog is more
on quality III and quality IV or what is normally known as medium quality of rice. When
the market price of rice declines during the harvest seasons in the period of February –
May, Bulog usually has to spend extra storage costs because of low quality of rice
procurement. Under the low farm-gate price, Bulog has to compete with private traders
in buying the rice from farmers. In this case, those who have better networks and special
engagement with farmers or farmers‘ groups would obtain more rice procurements, hence
higher marketing margins, in the process of rice trading. Whereas outside the harvest
season, Bulog might face difficulties in rice procurements because the farm-gate price is
quite high, well above the procurement price set by the presidential decree.
Indonesia has actually passed the Law No 9/2006 on warehouse receipt system
(WRS) which technically encourages farmers and farmers‘ groups to store in a certified
and standardized warehouse in a quite large volume, usually in the forms of non-husked
rice. The farmers or groups then obtain the receipts that could be used as financial
instruments or collateral for banking credits. The WRS is a simple form of price hedging
where farmers do not have to sell the products during the low price in harvest seasons. It
could develop into more efficient and effective trade financing in the future, which also
contributes to price stability of food and other agricultural products. The government
regulation No. 36/2007 on WRS has provided more detail implementation guidelines for
the hedging system in the field. In the last two years, the government has been in the
process of pilot implementation of several agricultural products in many provinces in
Indonesia. Examples of pilot project of WRS development in Indonesia are rice in West
Java, Central Java, East Java, and South Sulawesi; corn in Central Java and South
Sulawesi, coffee in Lampung and South Sulawesi, cocoa in South Sulawesi, pepper in
Lampung, etc. However, the results or the effectiveness of these WRS pilots could not be
assessed thoroughly as the implementation of the project is in its early stages. In shorts,
the participation from private sectors and constant supports from respective government
offices in the provincial and district levels are clearly important elements of success of
the WRS development in Indonesia.
17
3. Government policies affecting private sector involvement
There are several government policies affecting private sector involvement in the
rice industry, from the upstream sector in the farm, the downstream sector in the trade
and processing industry, and food security in general. The following examines such
policies, covering broader agricultural development policy, food security policy; more
practical price policy and trade policy; and more strategic investment policy and fair
competition policy.
(a) Agricultural Policy
Agricultural policy in Indonesia is a function of government strategy of economic
development. In the last four decades, Indonesia has implemented three important
policies in agricultural development: (1) intensification, (2) extensification and (3)
diversification. Intensification refers to any efforts to increase land productivity per
hectare, which implies the use of bio-chemical technology. The term extensification
refers to the land expansion by converting forest land and other uses to agricultural land
in order to increase food production. Diversification refers to efforts to spread the
agricultural risks and economic opportunities into several crops or farm activities.
Transmigration policies to distribute population from Java to the outer islands could meet
criteria for intensification and extensification, and probably diversification.
The success story of Green Revolution in rice production strategy in Indonesia is
usually associated with intensification policy where the government provided subsidies
for inputs: mostly high yielding seeds of rice and other grains, fertilizers, pesticides,
credits and other financing schemes to increase food production. Basically, the
government has spent large amounts of resources to modernizing the rice economy by
investing in a significant amount of budget to develop rural infrastructures to build the
foundation for a dynamic rural economy and development and dissemination of
technological packages of high yielding rice varieties, fertilizer, pesticides and technical
advice throughout the country. The government allocated massive amounts of public
resources in building warehouses, food managemet offices, and other infrastructure.
Rural cooperatives (KUD=Koperasi Unit Desa) collected rice from local farmers,
especially during the harvest season, and distributed rice, including imported rice,
especially during the poor planting seasons, drought and similar adverse situations. The
ultimate outcome was a remarkable increase in rice production in the country. Rice
production grew by 4.6 percent per year during the 1969-1990 period, significantly faster
than population growth of 2.1 percent. The rice yield rate grew by 2.7 percent per year,
contributing the increasing labor productivity as a proxy of overall welfare improvement
according to the well-known Hayami-Ruttan productivity identity (Arifin, 2008).
Increasing in land productivity of food crop in the last three decades can be
explained by a combination of several sources of production growth. These include
increases in cultivated area, cropping ratio and yields per unit of harvested area. In other
18
world, the sources of growth are increases in land expansion, land-use intensification and
yields phases, respectively. Improvement in the sources of production growth and
diversification also has a direct effect on increased land productivity. Technological
change through more intensive land-use practices such as application of fertilizer and new
varieties has increased land productivity. Improvement of irrigated land stimulates the
intensity of agricultural land use and increases the yields per harvested area. As the land-
labor ratio decreases, agricultural labor productivity can be improved by increasing land
productivity, for example through the progressive use of bio-chemical inputs.
At national level, the use of bio-chemical inputs corresponds negatively with farm
size but positively with labor force and irrigated land. This coincides with small holding
concentration in Javanese agriculture due to subdivision through inheritance and large
holding consolidation or uncultivated land outside Java. Given the limitation of fixed
supply of land, farmers with smaller holding utilize the land more intensively for example
by applying more bio-chemical and other land-saving inputs. While the larger holders
would face more complex management problems to apply more bio-chemical inputs and
would hire non-family labors despite a better access to credit or capital markets. More labor
force would be required to apply bio-chemical technology, including new varieties, fertilizer
and other chemical inputs, and other land "investment" activities such as land clearing,
leveling, and maintaining water channel of irrigation and or drainage system in lowland
land. While in upland land in which farmers mostly grow cash crops and secondary food
crops, more labor force is needed for fertilizing, weeding, and harvesting. In the steep
slopes of such upland land, land "investment" might include the adoption of conservation
practices to minimize land degradation, which is not discussed further here.
The three important agricultural policies of intensification, extensification and
diversification have also contributed to technological progress and stimulated agricultural
growth, particularly by sustaining food production in the country. As a result of these long-
term efforts, Indonesia achieved self-sufficiency level in rice production in the mid 1980s.
During the 1985 World Food Summit, President Soeharto received an award for
successfully transforming his country from being the largest rice importer in the world to
self-sufficiency. Morever, during the Soeharto administration, the government implements
and enforces price policies to balance the interests of rice farmers, who wanted profitable
prices; of rice consumers, who wanted affordable rice; and of rice traders, by allowing
them to befit from seasonal fluctuations in prices but avoiding serious distrortions. As a
result, the self-sufficency of rice in the 1980s was accompained with greater equality
among rice farmers, and between rural and urban areas, in several places in Indonesia.
However, Indonesian agriculture has started to face serious problems in declining
productivity and growth rate since the early 1990s, including resource degradation in the
formerly forest land converted for agriculture. Severe El-Nino driven droughts in
1992/1993 and pest attacks in many rice fields in Java, and price decline in some cash
crops have contributed to the flattening, if not declining, patterns of growth production
and productivity. Externality impacts of resource degradation in agricultural production
seem more dominant than the positive income transfer brought about by intensification
decision and land investment made for conservation purposes. Consequently, food crop
sector has to depend very much on import, where Indonesia has imported rice, corns,
soybean, etc, either for domestic consumption or for meeting the demand from agro-
19
based industries. The troubles continued during the economic crisis, agricultural sector
also suffered from the high rate of inflation. At the peak of currency devaluation in 1998,
agriculture seemed to enjoy windfall profits from exporting commodities such as coffee,
rubber, pepper, shrimp and other fishery products. This high economic return could not
offset the burden of agricultural sectors when low-skill urban workers have flocked into
rural areas because of huge number of lay-offs in urban sectors. Both formal and
informal workers have to find some jobs in rural areas, as the crisis hit more severely
some sectors in urban areas. When the case of huge rice import of 5.8 million tons and
1.5 million tons in 1998 and 1999 respectively, this trouble years period has been cited as
a period of mismanagement on food policy. The growth rate of agricultural sector in the
period of 1997-2000 was quite small, about 1.6 percent per year, while the rests of the
economy also experienced a severe contraction.
After the crisis, Indonesia has been under the Reformasi programs to recover the
economy and to decentralize the policy and decision making in all sectors of the
economy, except the monetary and finance, defense, law and religious affairs. A specific
agricultural development policy was launched by President Yudhoyono in 2005 to focus
on revitalizing agriculture, as a part of ―triple-track policy strategy‖ on pro-growth, pro-
job and pro-poor. This new policy strategy us really expected to alleviate 34 million of
poverty and to maintain food security for the country, as the agricultural sector is
believed as income multiplier and employment multiplier. In the last five years, the
growth of agricultural sector has revived to 3.45 percent per year. Except the food sector,
all three sectors of estate crops, livestock and fisheries have grown at a rate above 4
percent per year. Food sector still grow less than 3 percent per year, mostly because of
poor performance of rice sector, and other secondary food crops such as soybean, maize,
and cassava. The paths of revitalizing agriculture in such a political transition of
democracy and decentralization require logical translation from ideological and strategic
level of policy into a more operational policy formulation.
Even though no clear direction, recent literature and some empirical evidence on
decentralization policies generally does not show promising outcome for agricultural
development. As local government has more privilege and authority to formulate local
level policy for sectoral and regional development, nearly a thousand new rules and
regulations were passed at local level, primarily local taxes and retributions on various
activities of agricultural-related regional development. Some argues that the level of
business confidence has dropped significantly in association with increased
unpredictability, weak institutional settings of the current decentralization era. A primary
reason supporting the pessimistic view about decentralization and the regional autonomy
is that greater authority to formulate local-level budget does not always translate into a
better perspective of social justice. Fiscal decentralization is often interpreted as more
revenue (from natural resources and local taxes), instead of more responsibilities in
formulating local-level policies that can compatible for agricultural development.
Within the context of agricultural development, a positive atmosphere about
decentralization is that almost all districts and/or city and provincial government have put
high priority on agribusiness and agricultural development as one of the main priorities
for regional development. However, policies for agricultural development should not
stop only at the rhetoric level only, but rather go deep down into actual implementation
20
level involving several interested parties concerned with regional development and the
national development as a whole. Some have argued that increased power among the
elites in the regions has complicated the well-known corruption problems due to weak
rules of law in the country. In additions, business entities and other economic actors have
complained about increased country risks in the regions due to economic uncertainty and
business unpredictability of future benefit streams. What has been clear is that policies of
regional autonomy do not increase the amount of investment in the regions, while the
quality of road and other infrastructure has deteriorated at a pace faster than the ability of
local government can afford to rehabilitate in a short time. The challenging issues are
how to capture such local interests into a more orchestrated agricultural development for
to meet overall national objectives and policy reforms on reconstructing agriculture.
Table 5. Total Budget Allocated for Agriculture, 2004-2009 (Rp million)
2004 2005 2006 2007 2008 2009
1. Expenses central government 10,260.1 14,029.3 16,996.9 20,941.6 39,542.0 44,623.4
- Roles of agriculture, forestry
and marine-fishery (routine) 4,950.3 8,345.7 7,570.3 11,241.8 11,104.5
- Subsidy 6,113.5 9,070.5 8,651.2 13,371.3 28,340.2 33,518.9
1. Fertilizer 1, 171.4 2,527.3 3,165.7 6,260.5 15,181.5 17,537.0
2. Seed 74.2 147.7 131.1 479.0 985.2 1,315.4
3. Credit 34.9 38.6 34.2 47.5 77.0 1,679.5
4. Food 4,830.8 6,356.9 5,320.2 8,584.3 12,095.9 12,987.0
2. Direct transfer to regions 170.0 1,094.9 1,492.2 1,402.0 1,492.2
- Special Fund Agriculture 170.0 1,094.9 1,492.2 1,402.0 1,492.2
Total 10,260.1 14,199.8 19,091.8 22,433.8 40,984.0 46,115.8
Source: Coordinating Minister of Economic Affairs, August, 2009
For example, since the decentralization policy implemented in 2001, the local
government pay little attention on irrigation infrastructure, shown by small amount of
allocated for operation and maintenance of the irrigation system. If so, the budget is
spent for mostly personnel and routine expenditures, rather than on operational activities
to maintain the strategic functions of irrigation infrastructure to increase the harvested
area of rice, hence the total rice production in the country. The institutions and
institutional arrangements which were the backbone in supporting the irrigation system at
the local level, has now been inactive. Water-user association was very strong both in
policy lobby and in implementation water-related issues in the context of agricultural
development in the country. Water-use association today serves mostly as only a symbol
21
of levy and charges of agricultural development at local level, which is of course very far
from the principle of good governance, required by the modern democracy and
decentralization systems.
Indonesia needs to develop and rehabilitate at least around 7 million hectares of
irrigated land, but the structure of government budget seems not supporting infrastructure
development, which is really required to achieve sustained growth in food production and
agricultural sector in general. The structure of agricultural budget during the Yudhoyono
administration does not show the steps required to implement a very important policy in
revitalizing agriculture (Table 5). The total amount of budget spent for fertilizer subsidy
of Rp 17.5 trillion is probably too much, let alone the subsidy is not directly received by
farmers. The fertilizer subsidy has been given to the fertilizer industry, primarily in order
to pay the price increases of gas, as the main input of Urea fertilizer. Even though
Indonesia is one of the largest natural gas producing country in the world, the agreement
signed with gas-buying countries and increasing gas price in the world market has forced
Indonesia to ship the gas to export markets, instead of fulfilling the demand of fertilizer
industry. The government is now in preparation to formulate a more direct fertilizer
subsidy, with a probably higher retail price in the field. In 2010, the total budget of
fertilizer subsidy is declined to Rp 11.5 trillions, under the assumption of increasing retail
price of Urea and other fertilizers.
(b) Food Security Policy
Food security policy has affected the decision making process at the farm level,
trading level, processing level, and food consumption in the country. The main basis of
food security policy is Law No. 7/1996 on food and its government regulations No.
68/2002 on food security and 28/2004 on food safety. Indonesia has adopted the term
food security to be more strategic than simply food production activities, as food security
also deals with nutrition adequacy, access by the poor etc. Food security in this context
has several dimensions, but at least, containing four main components, namely: food
availability, accessibility, price stability, and utilization. If one of them missing, a country
could face serious food insecurity episodes. A very high price of food causes the majority
of population cannot afford to buy the food, the food security could be a serious problem,
even though the food is plenty and available in the country. Adequate food availability
means that, on average, sufficient food supplies should be available to meet consumption
needs. Stability refers to minimizing the probability that, in difficult years or seasons, food
consumption might fall below requirements. Accessibility draws attention to the fact that,
even with bountiful supplies many people still go hungry because they do not have the
resources to produce or purchase the food they need.
Therefore, food security can be defined as a situation in which all households have
both physical and economic access to adequate food for all members, and where
households are not at risk of losing such access. Food security can also be viewed at
different levels: for nations, regions or households. Ultimately, food security concerns the
individual or family unit, and its principal determinant is purchasing power at the income
adjusted for the cost of living. Similarly, purchasing power, income adjusted for the cost if
22
living. Purchasing power at the national level, i.e., the amount of foreign exchange
available to pay for necessary food imports, is a key determinant of national food security.
Therefore, food security is not only a question of poverty, but also the proportion of income
households to devote to food. The poorest people in the developing countries world spend
65 percent or more of their earnings on food.
Even though, the food production has increased steadily since 2007, the current
rate of food production in Indonesia is threatened in meeting the growing demand of food
consumption. In the last five years, rice production grows at below 3 percent per year,
while the demand for food is estimated to grow at 4.66 percent per year (according to
simple food-demand equation based on population growth rate at 1.3 percent, economic
growth rate at 5.6 percent and income elasticity on food is 0.6). When food production
domestically is inadequate, food import is necessary and economically justified even
though politically it seems not correct. However, when food-import dependency is very
high, food security may face a very serious threat because the world market is not stable
and food availability in the domestic market is very much affected by domestic food
production. In terms-of food availability, the surge of food production since the long-
drought of El-Nino and forest fires at the end of 1990s, and worsening trend of food-
stock management have affected the production systems. The slow progress of economic
recovery under the current government, the carryover of last-year high inflation rate has
also sharply lowered purchasing power of the society, increased the numbers of food
insecure, and affected the status of food security in the country.
In the last two years, the level of ―self-sufficiency‖ in rice seem to hold,
especially as a result of intensive national program to increase rice production (P2BN=
Peningkatan Produksi Beras Nasional) coordinated national in the office of former Vice
President Jusuf Kalla. The major justification in increasing food production is not only to
increase the food availability for the country, but to fulfill the ―political pressure‖ that
rice is very important politically. The share of rice in the income of the people and in
total economic output was very large, so much so that rice was known as the ―barometer
of the economy‖. Large fluctuations in prices would have meant large fluctuations in the
purchasing power of both consumers and farmers, and it would have been difficult for
many to adapt to these frequent changes. Moreover, the world rice market was thin and
unstable, much more so than other world grain markets, especially after the sharp
increase of world rice price since 2008.
In the demand side, food consumption in Indonesia grows significantly following
the growth of population and income level in the last two decades. The estimates of rice
consumption level vary by agency and organization, but the government relies on the data
published by the Central Agency of Statistics (BPS) that the per capita rice consumption
in the country is 139.5 kilograms, consisting of direct consumption, rice being used for
seed, and rice consumption by the industry. Important information related to rice
consumption also show that the majority (76 percent) of Indonesia households is net
consumer of rice and the rest 24 percent is net producer. In urban areas, 96 percent of
households is net consumer and only 4 percent of them is net producer of rice; while in
rural areas, the net consumer of rice accounts about 60 percent of rural households, and
40 percent of them is net producer of rice. Because of inelastic demand of rice, these
poor households generally suffer the most when the rice price-increase. This implies,
23
however, that cheap rice policy such as give-away rice subsidy to poor household cannot
be simply assumed as proper policy to alleviate poverty in Indonesia.
As mentioned breifly above, the food for the poor program is designed to reduce
the impact of severe economic crisis by providing 15 kilograms of medium-grade rice
every month to the targeted poor households. The rice-for-the-poor program is jointly
implemented by Bulog and fully supported by the National Budget, using a quite
complete data base of the neediest households such as compiled by the National Family
Planning Agency (BKKBN) to identify the neediest households. The data focus on five
indicators of overall standard of living and social affairs: food intake, housing, clothing,
and medical, and religious practices. Even though the program was designed as an
emergency-relief measure, it offers an alternative to rice price stabilization. In the near
future, however, the challenge is to sharpen the coast-effectiveness of the program: to
concentrate more of the assistance in urban areas, tighten eligibility criteria, increase
public awareness, improve beneficiary reporting, and ensure that the program is extended
and placed on a financially sound footing.
In order to reach the large numbers of excluded urban poor, the government plans
to involve non-governmental organizations in the distribution of subsidized rice and other
foodstuffs. A better public-private partnership in relief distribution could extend the
outreach of food-for-the-poor program as long as standards of program accountability are
well maintained. The crisis has drawn attention to the fact that assuring food security is
largely an income problem, that income levels can change rapidly, and that even some of
the most prosperous parts of the country have large numbers of households without food
security. The experience in the program is should improve food security policies in the
field by providing a better design for medium-term measures for providing assistance to
vulnerable households in the country. These might include some combination of targeted
food subsidies, ration shops, village granaries, food stamps, and subsidized food stalls.
Food security policy seems to be justified for the government to ban rice import,
such it was adopted during the President Megawati administration. Internationally in the
World Trade Organization forum and negotiation, Indonesia has been proposing to
protect four major commodities classified as special products (SPs), namely: rice, corn,
soybean and sugarcane, under the clause of food security purpose, rural security and
poverty alleviation. The current global financial crisis and food crisis due to world
instability has led to a situation where some food producing countries are pressured to
fulfill their national demands, rather than selling the food production in the global
market. The world market has become more complicated because it does not guarantee to
represent the most fair and efficient market system. As in most agricultural commodities,
developed countries have maintained a rigid protection policy to their agricultural sector,
providing a large amount of subsidy for their farmers. While developing countries do not
have the luxury to provide a significant amount of subsidy and protection policy to the
farmers, as the countries are still struggling to overcome their economic problems.
What becomes clear is that the level of rice consumption in Indonesia is now the
highest among Asian countries. Average rice consumption per capita in the most
populous country China is only 80 kg per year. The consumption level in Korea and
Japan is 70 and 60 kg respectively, which is a significant decline compared to the figures
two decades ago. Given that the production performance is somewhat dependent on
24
natural and economic volatility, high consumption level in rice would imply to the
amount of rice traded in the world market. Problems usually arise when the world rice
trade and distribution activities are not operated properly due to mismanagement in the
bureaucratic level of rice price stabilization and consumption subsidies. This very high
level of rice consumption could trigger more problems for the Indonesian economy
unless the diversification movement since the last decade is not only operational on
paper. This rhetoric movement should probably combine with the development of food
technology, a simple know-how but modern in nature, that complements and compatible
with the Indonesia‘s food production system.
(c) Price Policy
Indonesia has implemented price policy in rice since the New Order of Soeharto
administration. Since the establishment of parastatal agency of Bulog in 1967, the price
policy was aimed at keeping the rice price stable at the farm level and the consumer level.
The rice price stabilization policy was praised to be credible, transparent, and effectively
enforced by any levels of government, from central to regions. Two major policies were
implemented: First, a floor price kept the farm-gate price of rice well above the
production costs. Bulog bought rice production not absorbed by the market, especially
during harvest season. The procured rice was used to build a national buffer stock. The
economic rationales behind maintaining the floor price above the market-clearing level
were to protect against market failure, to ensure profitability of the farmers and to
procure enough rice for Bulog‘s operation. Second, a ceiling price made rice affordable
to low-income households, especially in the urban areas. Whenever prices went above the
ceiling due to drought and other natural calamities, Bulog would sell cheap rice to
targeted consumers. The argument in support of such market operations was to avoid
price spikes, which could trigger social unrest similar to the ones experienced by the
previous regime. This approach in price policy is sometimes known as ―price band‖,
where fluctuation is allowed to occur within the band of fllor price and ceiling price.
For more than three decades, the price band policy is effectively enforced, where
the price difference between producer or farm-gate price and retailer‘s or consumer prices
is not too wide to provide rooms for speculations, nor too narrow to allow certain
investment in rice trading and rice processing industry. The price differences were kept a
a range of Rp 300 to Rp 600 per kilogram for quite some times. However, since the
Asian Economic Crisis in 1998, the price differences between producer and consumer
prices were the highest in the history of rice. Since the fall of Soeharto in May 1998, the
price gap between farmgate and retail has spread as large as Rp 1,000 per kilogram or
US$ 0.85 per kilogram. This implies that the marketing margin of rice distribution has
been absorbed mostly by trading and processing activities, not by the farmers who have
remained weak price-takers. In the near future, rice farming could lose its attractiveness
among younger farmers, hence affecting the expected profitability it could generate. The
incentive issues for farmers have become even more complicated as declining
profitability of rice farming should be expected to provide incentive to move toward
diversification into more profitable farming practices such as horticulture, estate crops
and livestock. The food-for-the-poor and similar targeted policies have benefitted rice
25
consumers from paying a high retail price, which could prevent more absolute poverty in
the country.
This pricing policy was successful in the first 30 years of Soeharto administration,
in large part because the economic policy strategy was smoothly translated into
organizational and implementation policies down to local level. Bulog was highly
credited as a successful government institution in achieving price stability and effectively
contributing to achieving and sustaining self-sufficiency in rice. The success of Bulog
was characterized by a centralized management that had strong leadership and effective
organizational command to implement the policy. However, as the Indonesian economic
policy shifted towards more openness, adopting de-regulation policies in international
trade, banking, and finance, the closed and centralized management system within Bulog
started losing its effectiveness and acceptability. From the early 1990s, Bulog
performance attracted increasing criticism. The pressures on openness and democracy
during the later part of Soeharto regime raised concern for reforms in the bureaucratic
structure of the public administration. The stabilization policy became very expensive,
given its declining impact on food price, as the share of rice in consumer-spending fell
significantly.
(d) Trade Policy
The fall of Soeharto and binding letter of intent to the International Monetary Fund
(IMF) somehow changes trade policy in rice. Starting in 1998, rice imports were
liberalized and Bulog was no longer an agent that has sole monopolistic power in rice
imports. The average amount of rice imported was high enough to imply that Indonesia
has become more dependent on rice imports. The drought effects of El-Nino in 1997/98
on rice production seem so strong that the production level remains low and cannot meet
the growing demand of rice. In addition, mass delivery of subsidized farm credit during
President Habibie administration failed to stimulate rice production, primarily because
the policy is not well-supported by improvement infrastructure and institutions necessary
to deliver such a highly sensitive and politically susceptible credit policies.
However, the pressures to apply protection policy on domestic rice also grew
significantly during President Abdurrahman Wahid administration. Officially, the
government enacted a new policy on rice import using the Decree of Ministry of Finance
368/KMK.01/1999 on Import Tariff of Rice and Sugar, which was effective on January 1
of 2000. Import tariff for rice was set at Rp 430 per kilogram or approximately 30
percent of world price at exchange rate of Rp 9,500 per US dollar. The policy objective
is intended to protect rice farmers from price drops due to liberalized rice import with a
very low price in world markets, and implicitly to maintain domestic rice provision at an
affordable price level for rice consumers, living below poverty line. So the effective
protection now being provided to rice farmers can not be judged by the tariff, not by the
amount of credit Bulog can obtain at a market rate to defend the floor price, and not by
the stated procurement price which often means very little.
A number of arguments in favor of protection have emerged, such as the
unfeasibility for most Indonesia‘s small farms of 0.5 ha or less to compete with large,
26
well-capitalized and highly subsidized agro-business firms in the developed countries.
Uneven access to information, market infrastructure, and technology are among the
important factors that make the agricultural sector in Indonesia and in other developing
nations incomparable to the one in developed nations. Indonesian agriculture is especially
constrained by a scarcity of arable land, high rate of agricultural land conversion to other
uses, and low level of human resource development. Trade liberalization has been viewed
as a trigger to an import surge of several food crops and in reducing farm income and to
Regardless the import tariffs, however, rice imports occur even during the main
harvest season and there is ample evidence that a substantial portion of the rice is
smuggled or under-invoiced to avoid the import tariff. Price disparity between world
price and domestic retail price of rice contributes to the flow of rice imports to a wide
open and huge coastal areas and ports in Indonesia. Meanwhile, in the three years since
trade has been liberalized, rice production is two percent below the levels reached prior to
liberalization. On a per capita basis, the difference is even more significant. Per capita
rice production was nearly 10 percent higher in the years immediately proceeding
liberalization than in the three subsequent years of liberalized rice trade. Rice yields
were rising at a slow pace (approximately 1 percent per annum) for the decade prior to
trade liberalization. Since that time, rice yields have fallen by 0.15 percent per annum.
Rice area has continued to increase since 1998, suggesting that farmers have few options
other than paddy production on their flooded fields, but productivity is falling. This
would be consistent with low rates of profitability in paddy production and declining
levels of agro-input use (Tabor, et al, 2002).
What becomes worrisome for most policy makers in Indonesia is that trade
liberalization has increased the degree to which Indonesia depends on rice imports. The
import data published by the Central Agency of Statistics (BPS) shows that rice imports
after 1998 have more than doubled from the preceding years in the 1990s. Between 1995
and 1997, rice imports averaged 1.5 metric tons per year, but between 1998 and 2001,
rice imports have averaged 3.3 metric tons. As mentioned previously, rice imports were
the highest in 1998 and 1999, and with the resumption of good weather, fell in 2000 and
2001. The amount of rice imports was high again in 2002 as a result of flooding and low
producer prices. In 2003, where rice quality drops due to late planting season and high
rainfall in the harvest season, the growing demand of rice would likely be fulfilled from
imports, implying that the rice imports would be around 1.5 million ton or more. Rice
import continued to increase to 1.3 million ton in 2007, due to increasing demand in rice
and potential rents obtained from the marketing margins between domestic price of rice
and international price.
A study by Arifin et al. (2001) suggest that the policy performance of import tariff
confirms some phenomena of under-reporting or under-invoicing in rice import, even as
high as 50 percent from the actual import. The data on actual import might need further
verification, but judging from rice export data of final destination to Indonesia, such as
compiled by The Rice Trader the likelihood of under reporting seem quite strong.
Although, the causality between new import tax policy and under-reporting phenomena
need to be tested more rigorously using some econometric techniques, it is now very
clear that this on-site distortion has some consequences on incentive systems to the rice
producers, government revenues, and the whole set-up of food policy in the country.
27
The study suggests that import registration and customs management practices
suffer from a number of deficiencies that could contribute to smuggling and under-
estimation of rice imports. It appears easier to avoid customs duties and import tariffs
and controls if commodities are imported into the smaller, off-Java ports. Previously,
almost all rice imports were shipped into the main Jakarta or Surabaya ports. Since the
new trade policies, rice has been imported into small regional ports nationwide. The
study also found that the majority of rice importers operating out of the port of Medan
were registered under false names and false addresses and a small trader cartel dominated
both rice imports and wholesale trade. In additions, customs usually requires cash
payments; and the administration within customs procedures in Medan were not
computerized or otherwise linked to the banks. Under weak institutional arrangements
and poor policy enforcement, the traders might collude with the clearance agents (with
relations to customs) to "expedite" document approvals and release of goods. One should
note that the use of ―red line‖ custom‘s inspection practices appears to offer more
opportunities for collusion between custom‘s and clearance agents. This, in turn,
contributes to non-competitive trade practices since only a small number of importers are
able to work-the-system and avoid paying the full tariff at each port.
In 2008, Indonesia is finally not dependent on imported rice because the domestic
production increased significantly at a rate more than 3 percent per year. This import-
free situation is expected to continue in the current year of 2009. Even, Indonesia is
preparing to ―feed the world‖ where the government encouraged Bulog and private
sectors to export high quality rice to regional and international market. Actually,
Indonesia has been exporting high-quality rice to neighboring countries Malaysia, Brunei
and the Philippines although only in a very small amount of couple thousand tons. Since
2008, the government has assigned a special privilege for Bulog to export high quality
rice, after careful and comprehensive review of the status of buffer stocks and
government stocks of rice, managed by Bulog. If the domestic market of rice remains
stable, the private sectors will be then encouraged to export the high-quality rice to the
international and regional markets.
(e) Investment policy
Investment policy, such as stipulated in Law 25/2007 on investment, is intended
to develop new investment, both from domestic and from foreign origins. In its second
term, the Yudhoyono administration has not shown significant progress in providing a
conducive environment for new investment and businesses, as required for better quality
of economic growth in the country. One should note, however, investment and starting
new business in Indonesia is not a stand-alone problem, but closely associated with poor
business climate and investment attractiveness since the economic crisis in the end of
1990s and its derivatives of political, social or multi-dimensional crises afterwards.
Foreign Direct Investment (FDI) has not recovered, mostly because of high unpredictable
costs, legal security, bad governance and enforcement structures at all level of
government systems. Studies have shown that there has been no improvement in
―business-friendly environment‖ for potential investors, especially in the last five years.
28
Consequently, the competitiveness of the country as a whole has significantly decreased,
even at the lowest level ever since. It is clearly not an easy task to promote investment in
Indonesia, when the competitiveness of the country is really in trouble.
Moreover, during the last decades, food industry and resources-based industry in
Indonesia, has also suffered a serious ignorance from banking sector. Most financial
institutions do not put investment priorities in agro-based-industries, not because of bad
performance or poor prospects of the industries, but mainly because of poor
understanding from the banking sector. Advocates of agricultural sector, agribusiness,
agro-industry have faced serious difficulties to disseminate and convince the bankers and
fund managers regarding such a prospective sector of the Indonesian economy. As a
result, these people have wrong perceptions and maintain assumptions that agro-based
industries are considered a high-risk business, compared to the expected economic
returns and its multiplier effects to the rests of the economy.
Another explanation of low level involvement of banking sector in the very
potential resource-based industry is also related to the current monetary policy adopted in
Indonesia. Since its independence or after Law 23/1999, the Central Bank (Bank of
Indonesia) has not directly served as an agent of development for the country, but mostly
responsible for monetary authority, banking supervisory and inflation targeting.
Consequently, the Bank of Indonesia as the most significant monetary authority has a
freedom to maintain policy on interest rate rigidity, for the shake of inflation targeting,
which obviously hurt the resource-based sector, such as the agriculture. The banking
sector has to put the main priority to comply with the prudential banking principles so
that the strategy has been mostly to create rapid or short-term and high economic returns,
consumption credit such as vehicle, housing, and even a credit card. Investment credit
and working capitals are still considered long-term, slow rate of turnover, hence probably
a risky business.
In the 1970s and 1980s, Indonesia is used to implement subsidized credit policy in
order to boost investment in agricultural development. Early efforts to encourage farmers
to shift to high yielding rice varieties during mass guidance and other intensification
programs featured credit subsidies as one means of helping farmers finance their input
purchases. Subsequently, there have been many smaller programs to offer farmers credit
at rates lower than were available through traditional lenders such as input sellers, money
lenders, and more recently formal bank sources of lending at the village level, such as
implemented by a state-owned bank of BRI=Bank Rakyat Indonesia. And many projects
to encourage adoption of higher yielding varieties, including planting material for tree
crops, as well as better farm practices, have included some kind of interest subsidy. Most
of these programs have provided for limited quantities of subsidized credit, so that not all
farmers had access to this credit each year and most farmers who did could not obtain all
the financing they wished to obtain with subsidy.
During the Soeharto administration, the country‘s macro-economic policy was
well-managed, which resulted in relatively low and stable levels of inflation, and tax
burdens that were predictable and not terribly high. One of the most important elements
was an appropriately valued exchange rate. This is of particular importance to agriculture
because most of the sector is producing traded goods and prices are determined to a large
extent internationally. An overvalued exchange rate could have been a major tax on the
29
agricultural sector, yet this was not so in Indonesia. Part of these general economic
policies was the overall package of policies aimed at maintaining rapid economic growth.
This may have appeared to help mostly the urban sector, but the strong job creation
impact of this policy package when coupled with open labor migration policies allowed
rural and farm family members to migrate to those jobs in urban areas and increase the
disposable income of farm families substantially. At the expenditure side, there were
major government initiatives to invest in rural infrastructure, such as roads and
communications, which had direct beneficial effects on agriculture. Similarly, there were
major programs of expenditure in education and health care that emphasized the
provision of rural schooling and rural health clinics, improving substantially the quality
of labor services and human capital in rural areas in the longer term. In the vast majority
of cases these economy-wide policies helped the agricultural sector, often substantially,
such as rural infrastructure, rural schooling and rural health services.
Finally among intangible investment in agricultural sectors, there are research and
extension programs. This is an important category of investment in the agriculture sector
due its role in achieving productivity growth in agriculture. One major element of
research/extension spending is for salaries of government-employed researchers and
these salaries often fall under the routine budget. In Indonesia, the most tangible output of
research and development (R&D) is the release of rice varieties from the International
Rice Research Institute (IRRI) IR-5 and IR-8, which has been adopted in the
intensification programs in almost all irrigated areas in Indonesia. A study by Pasandaran
(2003) shows that irrigation investment in 1980s accounted for more than a half of the
total public expenditures on agriculture. Public investment in irrigation accounted for
more than 85 percent of irrigated area and 75 percent of the country‘s rice production.
Large amount of resources was put in place to ensure that production inputs were
accessible and affordable by farmers in all parts of the country among others are input
price subsidy and national delivery scheme for fertilizers throughout the country.
5. Constraints to private sector involvement
Private stakeholders from the production, trading, processing, storage and
retailing activities face serious problems, mostly related to physical infrastructures, the
complex social-economic relationships among the stakeholders and regulatory
environment in the processing and downstream industries. Constrains along the food
supply chain will be examined here, while the constraints on regulatory environment,
especially related to starting new business and other investment activities will be
examined in the next section.
(a) Constrains along the food supply chain
Rice farmers have to face stagnant agricultural infrastructures in the last decade,
especially irrigation and drainage systems which are really required to support the
increase in rice production and productivity. Currently, the government face serious
30
budget constrains – more precisely prioritizing the budget allocation – in developing and
rehabilitating the irrigation systems, hence new irrigated rice fields. Indonesia has to
rehabilitate irrigation infrastructures to fulfill additional irrigated land needed of around 7
million hectares, but the government budget is not enough for providing such amount.
This means that the strategy of revitalizing agriculture needs a significant amount of
additional budget for infrastructure construction, including financings from private sector
and foreign loan. The infrastructure building is very crucial to stimulate public
investment and effective demand in the rural areas, as conceptually it is impossible to
revitalize agriculture sector without developing the social and economic condition of the
rural region. Therefore, it is very important to support the rural industrialization, from
household industry, processing of products using simple technology, to trade and service
activities that are able to help increase their off-farm incomes.
In 2008, the project to improve the quality of irrigation infrastructures in order to
facilitate the development of new paddy fields reached only 4.8 million hectares, out of
7.6 million hectares irrigated land in Indonesia. Constraints are usually associated with
the availability of matching funds from the provincial and local governments, such as
required in the procedures of foreign-source development funding or loan agreement. As
mentioned previously, the local governments do not put priority in the development,
operation and maintenance of irrigation systems and agricultural infrastructures in
general. After the decentralization, most local governments are interested in revenue-
generating activities, rather than cost-center programs such as the operation and
maintenance (O&M) of irrigation infrastructures. The roles of local parliaments are
significantly central in determining the total amount and shaping the final allocation of
local budget. Narrow-minded local parliament members and poor governance system in
the region would determine the performance of irrigation infrastructures in the regions.
A simple calculation could be made from the above achievements, where as much as 2.8
million hectares of irrigated area are not utilized for rice production. This is equivalent to
the about 12.2 million ton production opportunity forgone due to the ignorance to
develop and maintain the irrigation infrastructures.
Similarly rice traders have to face a very serious problem of the quantity and
quality of road infrastructures, to support the movement of rice trading and inter-island
rice distribution in the country. The transportation costs have been the major component
of ride trading and other activities of rice movement from production centers to trading
centers to consumption centers. If the market structure is not really friendly or the market
failures of oligopsony or oligopoly persist in the supply chain, then private stakeholders
having weaker bargaining positions usually have to shoulder the burdens of high
transaction costs and inefficiency related activities. The government must build and
rehabilitate basic infrastructure of agriculture development, such main roads, production
roads, rural roads, irrigation and drainage channels, electricity network, water supplies,
etc. It has been proven that all of those facilities have become the success factor of rice
self-sufficiency in 1980s. The infrastructure development should function as stimulus of
public investment and effective demand in the rural level. With the support from rural
industry, simple processing products, and the trading activities that are expected to
accelerate farmers, incomes from off-farm side, in turn will affect positively and
gradually to community investment acceleration in other sectors of the economy.
31
The pattern of transaction between and among private stakeholders in the rice
supply chain could determine the shape and final outcome of rice trade in Indonesia.
Generally, the rice trading pattern depend on the marketing pattern for each regions. The
rice marketing as the process for distributing the rice commodity from producer to the
final consumers (end users) was conducted by different pattern and follow the marketing
channels. As mentioned previously in Chapter 3, the generalized marketing system of
rice trade in Indonesia consists of farmers as producers, collector traders at the village,
subdistrict and district level, wholesalers and rice milling units, Bazaar traders, retailers
and final consumers or end users or rice. For those involving in government-related
procurement process in Bulog, the marketing channels also consists of rural cooperatives
(KUD), rice-milling units (RMU), rice importers as the partners of Bulog. The patterns of
relations among the marketing institutional in the rice trading in Indonesia can be based
on trust, family and ethnic and usual business relations.
Trust Relations. In this case, the wholesale traders also serve as a broker by
storing rice from collector trader and selling to traders in other regions or retailers under a
fee-basis of charge, ranging from Rp 30.000 to Rp 50.000 per ton. Trust relations are also
practiced by village level collector-traders and farmers or farmers‘ groups. The
constrains in this case are very much dependent of the quality of governance system in
price discovery, where farmers are usually serve as passive price takers with low
bargaining position.
Family and Ethnic Relations. The family and ethnic-based relations occurred
among wholesalers and collector traders. The traders with certain family relations
practice other businesses in rice trading, such as rice processing unit (RMU), and other
networks with collector traders at the village and sub-district level. These collector
traders usually serve as a supplier to the main market place such as Jakarta Food Station
(JFS) in Cipinang of East Jakarta and Pasar Johar in Karawang. The constrains usually
faced by other private sectors outside the family relations include non-technical entry
barriers to the rice business, the tendency of asymmetric information in price, production
and market volume of rice being traded.
Usual Business Relations. Although, the usual business relations seem to be
simple, but in reality they occur under a quite complex non-written contract, the value of
business practices being adopted in the area. Large-scale rice traders or those having
more power are usually able to manage the risks by paying the rice being trade in their
place or after the rice arrive in their warehouses. Smaller traders usually have to be
prepared for a significant amount of capital before starting sending the rice out to the
larger-scale traders. For small-scale rice retailers, the capital needed for running rice
business at least is ranging from Rp 5 million to Rp 10 million. Medium-scale collector
traders have to control the capital at least Rp 50 millions to Rp 200 millions, while large-
scale traders have to possess Rp 300 million to Rp 500 million in their accounts. The
availability of these capitals is not readily available because of the problems in financial
institutions or banking system in the country.
32
(b) Constraints on Regulatory Environment
There are at least, four major obstacles commonly found in private sector
involvement in the rice industry and promoting new investment in general include: (1)
legal issues and enforcement structures, (2) unclear tax and custom procedures, (3) excess
of decentralization and regional autonomy, and (4) labor issues and industrial relations.
These issues and the following explanation on obstacles for investment in general have to
be understood properly, as a fundamental basis to recommend policy reforms in starting
new businesses and improving investment climate in Indonesia. Each of these major
obstacles will be briefly elaborated further.
Legal Issues and Enforcement Structures. Problems in legal issues, security and
weak enforcement structures are not new issues but have been recognized by private
sectors, new investors, and even the government. Informal fees and unpredictability in
doing business have lead to unpredictable costs, especially in starting new businesses. A
study by the World Bank (2007) has confirmed that starting new business in Indonesia is
very costly, taking an average of 151 days (5 months), involving about 12 steps of
procedures, and requiring as much as US$ 1,160. These numbers are the highest among
other East Asian countries such as Thailand and China which require less than US$ 60 to
start-up new businesses and the growing country Vietnam which requires only US$ 136.
Such unpredictability and legal security have influence business and investment
climate in Indonesia. Since the last five years or so, foreign direct investment have flown
mostly to China and Vietnam as the economic prospects in these socialist countries have
grown significantly. Intellectual property rights in Indonesia have also been complained
as very weak, especially when associated with increasing a large-scale smuggling in
recent years. Expectation on the second term of President Yudhoyono administration is
therefore very high, noting that the government has declared a war on corruption and bad
governance system and combated any wrong-doings in the bureaucracy from the central
to regional level.
Bad economic and physical infrastructures in Indonesia have also contributed to
the informal fees, leading to a high cost economy because the travel time and costs
associated with the flow of good and services were extremely high. Poor conditions of
roads, bridges and irrigation infrastructures have created opportunities on both officials
and informal levies. Weak administrations in the majority of ports in Indonesia have
been major concerns by domestic and foreign investors alike. These all have influenced
the level of competitiveness of the Indonesian economy which has been decreasing in the
recent years.
Unclear Tax and Custom Procedures. Unclear tax and custom procedures in
Indonesia have been complained by both domestic and foreign investors. Double
taxation is very common, where investors and other business entities have to pay value
added tax (VAT) and luxurious VAT on one commodity. No good criteria and indicators
on the ―intensification‖ tax strategy so that one taxpayer might have to ―negotiate‖ with
tax administrators. Procedure on tax restitution is very complicated, providing a grey
area of collusion between tax consultants and tax administrators, which obviously
33
harming the potentials of state revenue. Indonesia has been also known of poor law
enforcement on large scale businesses and taxpayers who have proven performing tax
evasion for a long period of time.
Table 6. Major Problems of Investment Environment
(% of valid responses to total responses)
Country
Insufficient
conditions of
infrastructures
Uncertain
and unclear
policy of
local govt
Troublesome,
complicated
tax practices
Troublesome
and complicated
customs and
trade procedures
Increase
employee
wages
Labor
issues,
strikes, trade
unions etc
Thailand 15.6 9.5 46.3 62.8 41.6 7.1
Malaysia 23.6 16.5 11.0 33.9 52.1 6.6
Singapore 3.1 6.3 12.5 21.4 54.0 1.1
Indonesia 54.7 67.7 72.0 67.6 86.4 37.0
Philippines 75.5 47.9 20.9 37.1 36.5 25.7
Vietnam 63.8 61.3 40.0 56.8 29.5 11.5
India 72.2 14.8 55.6 58.5 55.7 26.2
Source: Japanese-Affiliated Manufacturers in Asia -ASEAN and India-(Survey 2004)" JETRO
A survey conducted by Japan Economic and Trade-Relation Organizations
(JETRO, 2004) shows that the majority of private-sector respondents have complained
about tax administration (72%) (KADIN, 2004). They also claim that international trade
relations and custom procedures in Indonesia create more problems (67%), instead of
providing solution for international trade. This bad image on tax and custom is very
much worse compared to tax practices in Malaysia (11%) and in Singapore (13%), which
have been modernized since the last decades and easily accessible by public. Other
countries have adopted a strategy of ―low-rate high compliance‖, but Indonesia is still
struggling in tax intensification but the tax-ratio is well below 15 percent (Table 6).
A rate of 30 percent in business income tax on paper sometimes become 50
percent, mostly because of unpredictability in the public service such as the inclusion of
promotion tax, unless otherwise negotiated. This rate is extremely high compared to
income tax in Malaysia which has planned to cut the rate from 28 to 25 percent in 2005
or Singapore which plans to reduce the income tax to 20 percent. China has been famous
in the eye of investors because of a 15 percent income tax in the special zone for
economic development or in the prospective high rate of economic growth. Therefore,
China has been the most favored destination for foreign investment in recent years.
Decentralization and Regional Autonomy. As explained previously, Indonesia
has adopted a decentralization policy to transfer some powers to local government,
effectively since 2001. Initially, the local government enjoyed a new power under the
regional autonomy, even though it is too premature to offer an empirical statement on
how the new decentralization policies in Indonesia have contributed to good governance
and better public services in Indonesia. In fact, some have argued that increased power
34
among the elites in the regions has complicated the well-known corruption problems due
to weak rules of law in the country. Business entities and other economic actors have
complained about increased country risks in the regions due to economic uncertainty and
business unpredictability of future benefit streams as decentralization became effective.
Policies of regional autonomy do not increase the amount of investment in the
regions, but could contribute to inflationary effects because some new local taxes and
retributions were created after the autonomy. This obviously increases unpredictable
costs and the total burden of doing business in Indonesia. Studies by LPEM-UI (2001)
also indicate an increase in additional costs of 10 percent in Java and 11 percent outside
Java to deal with bureaucracy in the regions. Small and medium-scale enterprises (SME)
have to pay 11 percent additional production costs, while large-scale enterprises have to
burden only 8 percent additional costs in doing business in the regions after the policies
of regional autonomy. However, how deep the magnitude of these problems remains
important questions in the future because the public debates and opinion exchanges
around the issues mostly stem on the surface, rather than crawling down into the roots of
the problems. Studies by JETRO (2004) as cited in KADIN (2004) also confirmed that
about 80 percent of private sectors are not satisfied with the current implementation of
regional autonomy and decentralization policy in general. Unclear procedures to obtain
principle permit (ijin prinsip) and business permit (ijin usaha) from the local government,
factors of local politics and democracy in transitions have also contributed to higher
economic costs in investment and doing businesses in general. Therefore, poor images on
local government in Indonesia are obviously lower than those on local government
practices in Singapore (6.4%), Thailand (9.5%), Malaysia (16.5%) and India (14.3%).
Business society and general people are now putting a very high expectation on
the new decentralization policies, namely Law 32/2004 on local government and Law
33/2004 on fiscal decentralization, that replace the previous laws 22 and 25/1999. Some
substantial changes have been imposed in the new decentralization laws, especially to
improve efficacy of provincial government as a representative of central government in
the region and as a coordinator for local government. The new laws also put more
emphasis on direct election of the head of local government (regent and mayor) and the
local legislative cannot easily impeach the regent or mayor. It is very interesting to watch
over more closely on the reaction of local elites, government officials, legislative
members, and civil society to the new laws in the near future.
Labor Issues and Industrial Relations. Labor issues and industrial relations
between the employers and employee are perennials and sometimes very sensitive when
entering the wage rate and related labor policy involving the government. Employers or
business entities complains about the current minimum wage policy, especially in
relations to the productivity of labor force in Indonesia. Business sectors have now to
face a tendency that the increase in wage rate exceeds labor productivity and the rapid
movement of labor unions which exceeds the ability of the private sectors to adjust to
more democracy. In 2004, the majority of business sector (86%) has complained about
the increasing wage rate but lowering labor productivity (KADIN, 2004). Most foreign
and multi-national companies do not understand and do not want to learn the
complexities of industrial relations. However, efforts to mediate and establish mutual
dialogues on these issues do not result in a better way out for improving the
35
competitiveness of the Indonesian economy in general. The dissemination procedures to
achieve better industrial relations are not effective in mediating the tripartite of
employers, employee, and the government.
At micro level, a component of wage rate is very significant in shaping the cost
structures of businesses in Indonesia, especially when fixed costs and other burdens of
doing business in Indonesia are the highest in Southeast and East Asia. Labor unions
have complained that the minimum wage rate could fulfill the basic-needs requirement to
live in big cities such as in Jakarta, Bogor, Tangerang and Bekasi where the average
inflation rate is also high. Actually, both employers and employees expect better
solutions in the newly formulated regulations of regional minimum wages. Unfortunately,
the difference in detailed assumption used by employers and employee cannot be
mediated properly by the government because the two have a very different objective.
In additions, business sectors are not satisfied with the limitation of outsourcing
and contract recruitment, such as commonly adapted in the principles of flexible labor
market in the different parts of the world. However, the labor force has constantly
making pressures to increase the job security and property rights in the growing
competition of global economy. One-way traffic of decision making in the business
organizations – and sometimes authoritarian and unfair for the labor – has to be reformed,
by promoting more business governance and corporate social responsibility so that the
property rights of each party could be secured. The transitional phenomena of labor
market and growing democracy in the society have somehow affected the pace of labor
productivity improvement in the private sector.
Example of rules and regulations in the labor sector that has been constantly in
dispute include Law 13/2003 on employment and Law 2/2004 on settling up the disputes
of industrial relations. These two laws are not well accepted both by labor unions and
business entities and have served as a source of disputes recently in the policy making
process. Labor unions accuse that the laws are too liberal and serving only the interests
of employers or the private sector development in general and putting less attention on
the welfare of labor force. Business entities also blame that these laws are formulated
very much for the interests of labor protection, but at the expense of investment climate
and economic development in general.
36
6. Concluding Remarks: Policy Implications
This paper has examined the roles of private sectors in Indonesia‘s rice industry,
covering the structure of industry, the private sector involvement and in government
policies affected the roles of private sector in the industry. The paper reveals that rice
industry in the country is the major industry, employing more than 12 million people
from upstream to downstream industries, from rural to urban areas. The state-owned
enterprise Perum Bulog also plays very important roles in the industry, although the total
volume of rice traded and for rice procurement though Bulog is less than 10 percent of
the total 38 million ton of rice production in Indonesia. Bulog lost its power in price
stabilization when the government adopted trade liberalization in rice trade for about two
years in 1998-2000. However, after the current global food crisis and domestic rice
production increased steadily, Bulog is able to procure well above 7 percent average and
reach 3.8 million ton in stocks, a record high of buffer stock and government stocks of
rice in the modern rice history of Indonesia. As a result, rice consumers of Indonesia do
not have to pay high retail prices compared to their neighbors such as in the Philippines,
Malaysia, Thailand and Vietnam.
The paper also reveals that food security strategy in relation to the rice industry
development should be integrated with to macroeconomic policy as a whole. This should
start with accelerating rural development, focusing on increasing income of the lowest
quintile. Such an equality dimension is also very relevant with people-based development
strategy. Accelerating rural development should be supported with improving the access
on resources and factor of production among rural people, especially the lowest income
group. In addition, this rural development strategy would lead to employment generating
activities, more balanced income transfer and stability of food supply, and compatible
with improving food security from household level up to national level. For example,
Indonesia should explore policy alternatives on rural development dimension of food
security strategy such as empowering rural-level economic institutions, including: (1) access
on better public infrastructures such as: roads, irrigation, electricity, schools, etc., (2) market
institutions such as credit market, labor market, fertilizer market, etc (3) access on market
information, (4) farm-holding structure, and (5) physical characteristics such as climate and
supporting social structures. Equally important is the improvement of food diversification
strategy such as integrating with food technology development. This strategy would increase
added value of the products and could contribute to the direction of industrial development
in the country.
The policy reforms and implication suggested by this paper is that the government
should conduct the following: (a) improve legal arrangements, (b) simplify tax policy and
administration, (c) improve public services at regions, and (d) develop employment-based
investment strategy. The first step to attract investment in Indonesia is to establish ―rule
of law‖ and secure its enforcement. This pre-requisite is very important to build a good
image about business climate in Indonesia and especially compatible with the triple
strategy of the new government administration. Streamlining various permit and license
procedures could be seen as a serious reform process about rule of law on investment and
37
industrial development policy in general. Clear policy in improvement in basic
infrastructure is also important to secure the flow of good and services and to maintain
low and affordable utility cost for investors. The government could start to develop
incentives system for deepening downstream industries, such as tax-deductible system for
agro-industry new investment. Incentive system in price differences between high
quality and low quality products would create more opportunities for upstream industries
to improve the yield and encourage higher quality of upstream products in general. This
could be possible when these steps are formulated in such a way and integrated with
other agro-based industry and broad-based development policies.
Second, tax policy and administration reform should start with simplifying taxing
procedures in order to avoid informal fees. The form of tax obligation, especially for
corporate (and individual) income tax has to be periodically received by tax payers on
time. Tax compliance could be increased by improving the quality of service among tax
administration officials. Transparency in tax administration could be speeded up by
utilizing information technology for the filing system and procedures. This could reduce
the opportunity for ―tax bargaining‖ regarding the amount and scope of tax objects.
Special treatment and tax deductible could be given for downstream companies investing
in research and development (R&D) and human resource development (HRD) to broaden
the downstream industrial development. Incentive systems for agro-based industry
aiming to enter international market are necessary steps to show the government
commitment on value-added creation. Export credit, deduction in import tariff for
working capital, and possibly non-excessive export tax are among the general instrument
for the incentive systems. In the mean time, empowering the front-line of actors involved
in international trade has to be sharpened, especially to improve the preparedness of these
key actors in a more open and competitive global market. Finally, adequate diplomacy
support is also necessary in the international fora and economic cooperation such as
AFTA, APEC, WTO, etc.
Third, the steps to improving public service at regions could start from the fact
that every-single district autonomy could serve as a motivating and facilitating agent,
instead of being an actor in regional economic development. At least, these regions have
to provide and facilitate exchange information on data and information about resource
endowments: land, labor, capital, and technology for downstream industry. Capacity
building for bureaucracy or government officials and legislative members at local level is
a fixed variable to improve the public service at regions. At the same time, improving
awareness of civil society at both local and regional level could also contribute to
foundation of economic policies and more sustainable outcome for the welfare of local
people and the nation as a whole. The main principle in one-roof service window is that
broad authority to facilitate new investment could be assured. New and existing
investors, both domestic and foreign companies could have a security feeling and
predictability level in executing their businesses in the field. The central government
should have more power to withdraw rules and regulations at local level which have a
conflict and against higher laws and regulations at national level. Therefore, the room of
maneuver of rent-seekers and ―usual suspects‖ could be limited so that the impacts of
economic distortions at local and national level could be reduced.
38
Fourth, a thorough review on the existing law such as Law 13/2003 on
employment and related ministerial decrees has be conducted before aiming at creating
new law on employment. Equally important is on the newly passed Law 2/2004 on
settling up the disputes of industrial relations, which has generated conflicts and different
perceptions among employers and labor unions. The main goal of the employment-based
investment strategy is to develop win-win solutions both for investment strategy and
employment creation in general. The principles of labor flexibility should not be
interpreted simply as weak property rights for labor force, but rather to establish
adjustment mechanisms based on real wages, instead of lay-offs. The principles in labor
market flexibility would rely on government support programs on unemployment when
the economy experiences serious external and internal shocks. For Indonesia with a huge
amount of informal labor market, flexibility in labor market could also imply outsourcing
and flexible recruitment mechanisms in order to provide a mutual bridge between
informal and formal sector. In this case, the investment in resource-based industry could
be more attractive for private sectors and business entities interested in agro-industry
development in general.
Finally, rapid changes in trade liberalization and globalization should also be viewed
as a stimulator to increase every single opportunity in domestic policy, instead of great
threats for food security and agricultural development. The phenomena of trade
liberalization could be regarded as a vehicle towards a ―fair‖ competition in science,
research, technology, and diplomacy at international forum to better prepare economic
actors, government apparatus, and civil society in general. This should be complemented
with capacity building of the frontlines of economic actors, private stakeholders and policy
makers in rice industry, food security and agricultural development in general.
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