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Cablegate: Soaring Food Prices Prompt Large Stabilization Plan

VZCZCXRO5692
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #0286/01 0430847
ZNR UUUUU ZZH
R 120847Z FEB 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 7966
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHRC/USDA FAS WASHDC
RUEHKO/AMEMBASSY TOKYO 1513
RUEHBJ/AMEMBASSY BEIJING 4716
RUEHBY/AMEMBASSY CANBERRA 1991
RUEHUL/AMEMBASSY SEOUL 4395
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 000286

SIPDIS

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-SETH SEARLS AND JWEEKS
SINGAPORE FOR SBAKER
TOKYO FOR MGREWE
COMMERCE FOR 4430/BERLINGUETTE
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN
DEPARTMENT PASS EXIM BANK
USDA/FAS/OA YOST, MILLER, JACKSON
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER
USDA/FAS/OGA CHAUDRY, DWYER

E.O. 12598: N/A
TAGS: EFIN EAGR ECON PGOV ID
SUBJECT: SOARING FOOD PRICES PROMPT LARGE STABILIZATION PLAN


1. (SBU) Summary. Upward pressure on food prices in Indonesia is
unlikely to subside in their near term, presenting considerable
hardship for poor households. In an effort to combat food price
inflation, the Government of Indonesia (GOI) announced a large-scale
food price stabilization program. The program includes significant
price subsidies, a reduction in import duties, a continuation of
export duties, and incentives to increase and diversify crop
production. The new program will have a substantial short- and
potential long-term impact on government finances and policies.
Analysts also question the sustainability and effectiveness of price
subsidies to control inflation in Indonesia. End Summary.

Pressure on Food Prices Unlikely to Abate
-----------------------------------------

2. (SBU) Pressure on food prices in Indonesia is unlikely to subside
in their near term due to a host of international and domestic
factors. A drought in Australia, other weather-related problems in
the United States, Canada and Europe and a reduction in planted
areas in the developed world have reduced global yields of wheat and
soybeans. Demand for alternative energy sources has prompted
farmers to increase corn and palm oil production for biofuel use at
the expense of crops for human consumption. Land use policies that
limit the size of plots available to individual farmers keep larger
and more efficient farms from forming. The GOI approval process for
hybrid seeds that could increase yields is extremely slow; the
approval process for bioengineered seeds is worse. Indonesia's
aging irrigation systems and poor rural infrastructure also limit
the farmers' ability to respond to increased demand.

3. (SBU) Most analysts note that high food prices will eventually
prompt supply side adjustments that bring food price inflation under
control. However, this adjustment process may be slower than in
previous cycles, particularly in Indonesia. While observers expect
the Chinese and Indian economies to cool in the wake of the decline
in US growth, most also expect food demand from those countries to
remain robust. High oil prices will keep the demand for alternative
energy sources elevated. Also, significant land and seed policy
changes and large levels of investment in rural infrastructure in
Indonesia are unlikely.

Food Costs Exacerbate Poverty Levels
------------------------------------

4. (SBU) Soaring food prices put significant pressure on Indonesia's
poor and near poor, a group that represents over 40% of the
population. Staple foods, such as rice, soybeans, and palm oil
(used for cooking), which are now relatively high priced, comprise
roughly 50% of these families' household budgets. Moreover, as food
prices rise, the quality of food products available to poor families
usually deteriorates, contributing to health problems. Anecdotal
evidence suggests that last year's spike in rice prices forced poor
families to consume rice containing mold and other contaminants.
High rice prices are responsible the use of so-called "recycled"
rice by low-income consumers, basically rice recovered from
restaurant dust bins. Recent data suggest that higher food and
energy prices have prompted stronger overall inflation in Indonesia.
Headline inflation rose to 7.4% (YOY) in January, up from 6.6%
(YOY) in December. The month-on-month increase in prices from
December to January was 1.8%, up from 1.1% the previous month. If
inflation expectations begin to rise, calls for wage increases,
which put further pressure on prices, could also intensify.

Large-scale Stabilization Plan Announced
----------------------------------------

5. (SBU) The Yudhoyono government is under significant pressure to
get food prices under control or risk significant backlash at the
ballot box in 2009. GOI contacts have told us that this is one of
the Yudhoyono administration's top priorities leading up to
elections. On February 4, Deputy Chief for Coordination of
Agriculture and Marine Resources Bayu Krisnamurthi announced a host

JAKARTA 00000286 002 OF 003


of new and ongoing policies designed to stabilize food prices. The
policies include soybean price subsidies for small-scale producers
(Rp 1,000 per kg), rice price subsidies (Rp. 1,600 kg) for 15 kg of
rice per household per month, and cooking oil price subsidies (Rp.
2,500 per liter) for poor families. In addition, the GOI will
temporarily eliminate import duties on flour and soybeans, and lower
import duties on rice to Rp 450 per kg from Rp 550 per kg. The new
policies also relax import standards for wheat.

6. (SBU) The stabilization plan includes provisions to raise the
export tax for palm oil and derivative products from 10% to 15% and
expand the categories of cooking oil eligible for government-paid
value added tax for domestic sales. The GOI also announced policies
to accelerated the provision of high quality seeds and promote the
development of wheat alternatives.

Fiscal Cost High
----------------

7. (SBU) The total cost of the program and its financing remain
unclear. On February 5, Indonesia's Energy Minister Purnomo
Yusgianoro stated that the GOI would shift Rp 25 trillion ($2.8
billion) in budget funds, previously allocated for fuel and
electricity subsidies, to fund new food price subsidies. The
Ministry of Energy (MOE) also stated that the shift in funds from
fuel to food subsidies is dependent on the GOI changing its oil
price budget assumption from $60 a barrel to $80 a barrel.
According to our contacts at the Ministry of Finance, the change in
assumption raises the total amount of funds allocated for fuel and
electricity subsidies (before moving funds to the food sector) by Rp
69.1 trillion ($7.6 billion) to Rp 144.7 trillion ($15.9 billion).
The GOI currently estimates that the price of the entire food
stabilization package (including food subsidies, lower import duties
and higher export taxes) will be Rp 13-14 trillion ($1.4-$1.5
billion).

8. (SBU) The large cost of the program will put pressure on the 2008
budget deficit, initially projected at 1.7% of GDP. The cost of the
food stabilization program alone, at Rp 13-14 trillion, will raise
the deficit by 0.4% of GDP, regardless of where the government
generates the funds. At the same time, Indonesia's budget is under
pressure from rising oil prices. Changing the price assumption for
fuel to $80 a barrel will increase the budget deficit by 1.8% of
GDP. The IMF calculates that every $10 increase per barrel in the
price of oil, worsens the fiscal balance by 0.1% of GDP, but notes
that the impact is not linear as fuel smuggling and other issues
come into play as well. Few analysts expect the actual global price
of oil, currently close to $90 a barrel, to drop in the near term,
suggesting the actual cost of energy subsidies may be even higher.
(Note: The GOI will partially fund the food subsidy program by
diverting funds from energy subsidies, meaning the total impact of
the food price package and raising the budget assumption will be
less than the sum of their impact. End note.)

9. (SBU) The food stabilization program also has long-term
implications for the budget and the economy. The large fuel
subsidies that the GOI removed in 2005 mainly affected wealthier car
and motorcycle owners. Food subsidies largely help the poor, making
their removal politically difficult. Although GOI has limited the
soybean stabilization policy to six months, if the global soybean
price remains firm beyond the six-month horizon, discarding the
subsidy policy will likely entail a political cost.

Longer-term Impact of Policies
------------------------------

10. (SBU) Views on the effectiveness of the policy package are
mixed. Most analysts applaud the GOI plan to stimulate agriculture
production and remove import duties, but believe the retention of
export taxes on cooking oil will be ineffective. Observers also
note that the longer the food price subsidies are in place, the
greater the costs. If global prices continue to rise as expected,

JAKARTA 00000286 003 OF 003


the GOI must increase subsidies to keep pace. The corresponding
increase in the budget deficit could prompt a loss of confidence
among investors and undermine Indonesia's hard won macroeconomic
stability. Food price subsidies can also lead to hording; the
subsequent shortages can lead to significant unrest, undermining the
initial objective of the policy.

11. (SBU) Artificially lower food prices also reduce Indonesian
farmers' incentive to increase production and lower the quality of
food imports. A local representative from Cargill recently observed
that price ceilings would force his firm to export markedly lower
quality beans to Indonesia. The government has already announced
lower standards on wheat imports. The significant cost of the food
subsidy program also makes large-scale investment in rural
infrastructure much less likely, further clouding growth prospects
for the agriculture sector and job growth in rural Indonesia.

HEFFERN

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