FOCUS : CHALLENGES FACING EFFORTS TO PROP UP MANUFACTURING AND AGRICULTURAL SECTORS

INDONESIAN COMMERCIAL NEWSLETTER

May 2006

FOCUS

CHALLENGES FACING EFFORTS TO PROP UP MANUFACTURING AND AGRICULTURAL SECTORS

The government seems to have been at a loss how to revive the real sector especially the manufacturing sector from long slump. The sector has remained in the doldrums with seemingly unending misfortunes besetting it such as fuel price hikes, increase in interest rate and weak purchasing power of the general consumers. The poor condition of the manufacturing industry is marked by a decline in turnover of manufactured products in 2006. Industrialists said the decline was estimated to each as high as 40%-50% in the first half of this year.

Sales of automotive products - cars and motorcycles - were on the decline in the first three months of this year. Motorcycle sales shrank by 26.14% in the first 4 months of this year.

Food and beverage manufacturing industry fared not better. The industry, which had always reported strong growth earlier was getting sluggish in 2006. Based on data at the Central Bureau of Statistics (BPS) food and beverage processing industry grew only by 1.27% in the first quarter of 2006, slowing from 4.73% recorded in the same period last year. See the following table.

The setback caused by the oil fuel price hikes late last year, the volatile rupiah fell in value by the end of last year facing U.S. dollar appreciation that caused a steep fall of many other currencies including rupiah. As a result Bank Indonesia raised the interest rates in a bid to keep the rupiah from diving deeper.

The fluctuation began to recede in the last three months. The rupiah was stable at the level of 9,000 to the U.S. dollar and the central bank was able to maintain its key interest rate (BI Rate) at 12.75%. Inflation was under control.

However, the improvements in the macro economic condition did not have immediate effect on the real sector. The interest rate was still to high although the central bank later cut the BI rate by 25 basis points to 12.50% The interest rates on credits remain high at more than 16.5% although declining from 17.5% several months earlier.

Business leaders said the central bank should make a bigger cut in the interest rate to allow banks to cut their credit interest rate to as low as 10%-12.5%. The central bank, however, chose not to rush to take drastic measure. A big cut in interest rate could cause a reversal in the flows of capital, which begins to show stronger inflows to the country lately.

The present level of interest rate will also allow the central bank to maintain the relatively high level of its foreign exchange reserve especially with the government's decision to fully repay the US$7.8 billion debt to the IMF in two years. Repayment of the debt will mean a cut in the foreign exchange reserve, but by maintaining of the interest rate the effect would not be too much on the rupiah.

Under such condition, further cut in the interest rate will be risky especially as the U.S. Central Bank is still expected to raise its interest rates. The condition, therefore, will remain unfavorable for the real sector.

Meanwhile, the cash strapped government could not do much to improve the condition of the manufacturing sector. The present monetary stability is not the condition expected by both the government and Bank Indonesia as the stability is still highly vulnerable to external pressure.

Credit for agribusiness sector

While, the manufacturing sector remains in the doldrums, the government has taken more concrete steps to boost development of the agricultural sector including agribusiness.

In a limited cabinet meeting in May, 2006, the government pledged subsidy for Rp 12 trillion credits to be issued by state Bank Rakyat Indonesia (BRI). The credit fund will be used to finance program to revitalize the plantation sector and develop agricultural commodities including palm oil, rubber, cacao totaling Rp 10 trillion and expansion of corn plantations in Sulawesi to cost Rp 2 trillion.

The subsidy pledged by the government will be more or less the same as it provides for food resilience credits under which the government pays half of the 18% interest rate with the other half to be paid by farmers.

The credits for revitalization program are offered not only for small farmers but also for large plantations in line with the government program to boost the country's production of palm oil to 20 million tons a year in the next several years. The government hopes to increase the country's CPO production to 20 million tons a year by planning to open 2 million hectares of new plantations with an investment of Rp 20 trillion.

Expansion of oil palm plantations, however, faces difficulty with limited availability of land . Land acquisition is more expensive with the limited land available causing plantation project less feasible.

In the past five years, credits for the agricultural sector has been relatively small. Based on data from Bank Indonesia, the amount of credits for the agricultural sector rose from Rp 20.7 trillion in 2002 to Rp 29.4 trillion in 2005.

Working capital credits dominate credits extended to the agricultural sector. In 2005, working capital credits accounted for Rp 16.7 trillion of the total credit of Rp 29.4 trillion extended to the agricultural sector. The rest were in investment credits totaling. Rp 12.7 trillion. The additional fund of Rp 10 trillion in revitalization credits for the plantation sector, will contribute to expanding oil palm plantations and reviving the real sector related to the agribusiness.