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Cablegate: Response: Impact of Rising Food/Commodity Prices-Inodonesia

VZCZCXRO1777
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #0868/01 1210859
ZNR UUUUU ZZH
R 300859Z APR 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 8882
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/USDA WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 1910
RUEHBJ/AMEMBASSY BEIJING 4999
RUEHBY/AMEMBASSY CANBERRA 2432
RUEHUL/AMEMBASSY SEOUL 4555
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 05 JAKARTA 000868

SIPDIS

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS
DEPT FOR EEB/TPP/ABT/ATP JSPECKS
TREASURY FOR IA-SETH SEARLS AND JWEEKS
SINGAPORE FOR SBAKER
TOKYO FOR MGREWE
COMMERCE FOR 4430/BERLINGUETTE
USDA/FAS/OA YOST, MILLER, JACKSON
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER
USDA/FAS/OGA CHAUDRY, DWYER
USTR FOR WEISEL, EHLERS

E.O. 12598: N/A
TAGS: EFIN EAGR ECON ETRD PGOV ID
SUBJECT: RESPONSE: IMPACT OF RISING FOOD/COMMODITY PRICES-INODONESIA

REF: STATE 39410

SENSITIVE BUT UNCLASSIFIED

1. (SBU) Summary: The price of most Indonesian staple foods
(soybeans, wheat, palm oil, instant noodles, chicken, eggs) has
risen rapidly in the past year. In contrast, the cost of rice, the
largest component of the Indonesian diet, has declined in Indonesia
over the last twelve months. However, the international price is
now $700 per metric ton (MT) higher than the price in Indonesia,
creating an incentive to smuggle and hoard rice and putting pressure
on local prices. Rice accounts for roughly one-quarter to one-third
of poor and near poor household spending. Production of palm oil,
rubber, coal, and metals has increased in Indonesia in response to
higher prices. Food production has been slower to respond. There
have been numerous protests against rising food prices in recent
months, but none have been violent.

2. (SBU) Summary (Con'd): The rise in food prices has already
translated into higher overall inflation in Indonesia. Analysts
worry that the need to aggressively fight inflation and slowing
world demand will push Indonesia's growth rate below 6.0%, with
limited potential for new job creation or poverty alleviation. GOI
policies to respond to the food crisis center on increased subsidies
and revised trade policies rather than longer term investments in
agriculture. Post recommends the GOI take a comprehensive approach
to the food price issue that includes cash transfers to alleviate
the burden on poor households and policies to revitalize the
agriculture sector. Post also recommends that Indonesia and the
U.S. coordinate with countries in the region to discourage rice
hoarding. End Summary.

Jakarta Cables on Food/Commodity Price Issues
---------------------------------------------
3. (U) Post has reported on the political and economic impacts of
food prices in the following cables: Jakarta 86, Jakarta 204,
Jakarta 216, Jakarta 264, Jakarta 286, Jakarta 671, Jakarta 684,
Jakarta 762, Jakarta 780, Jakarta 848, 07 Jakarta 2857, 07 Jakarta
2997, 07 Jakarta 3027, 07 Jakarta 3056, 07 Jakarta 3208.

Demand
------
4. (SBU) Rice is the most important food source in Indonesia. Rice
accounts for roughly one-quarter to one-third of poor and near poor
household spending. With roughly 50% of Indonesia's population at
or near the poverty line, a rise in the price of rice could
substantially reduce the standard of living of over 100 million
Indonesians. The World Bank estimates that every 10% rise in the
price of rice puts an additional 2 million people below the poverty
line (income of $1.55 a day or less). In contrast to the
international price, the cost of rice has declined in Indonesia over
the past year, as rice prices were already high relative to
international prices in 2007. But the international price is now
$700 per metric ton (MT) higher than the price in Indonesia,
creating a significant incentive to smuggle rice out of the country
and raising the risk that prices will climb again rapidly this year.
Although analysts expect the rice harvest to be better than last
year, the U.S. FAS projects that Indonesia needs to import roughly 1
million tons of rice before at the end of the year to meet
consumption needs. Recent studies reveal that 80 percent of the
Indonesian population consumes more rice than it produces. In
addition, in contrast to other economies, high rice prices have
tended to lower real incomes in rural areas in Indonesia, the
experts warned.

5. (U) Indonesians also consume large quantities of sugar, soybeans,
flour (mainly as a base for instant noodles), palm oil, chicken and
eggs. The retail price of flour and soybeans have risen 70% and
44%, respectively, in the past 12 months. The price of cooking oil
and instant noodles are up roughly 30% in the past year. The price
of sugar has remained fairly constant this year. High prices for

JAKARTA 00000868 002 OF 005


Indonesian staple foods are likely to persist given that inadequate
harvests, growing demand from emerging markets, and increased use of
food to produce alternative sources of energy continue to push up
international prices. The high price of soybean meal, which farmers
use as poultry feed, has also helped drive up the price of chicken
and eggs, a key source of protein in Indonesia, by roughly 30% over
the past year. The rise in food prices has already translated into
higher overall inflation in Indonesia.

6. (U) Analysts expect high rice and other food prices to hit
hardest in Java, where income and job growth remain limited.
According to executives at Indofoods, sales of wheat base products
fell most dramatically in Central Java when the price of wheat began
to rise, providing support for the view that purchasing power is
lowest in that area. Anecdotal information suggests that
Indonesians are responding to higher food prices by buying smaller
quantities of food more often and in some cases substituting lower
cost alternatives.

7. (SBU) Java is also likely to be the source of most rice smuggling
efforts as roads and transportation links there are superior to most
other parts of the country, making it easier for illegal traders to
move goods. According to discussions with local traders,
inter-island trade is up substantially this month, from around
200-250 MT/month to around 500-600 MT month. Traders note that the
increase in activity reflects pre-positioning in rice deficit
regions in anticipation of local price increases. However, experts
also worry this could be an early sign of smuggling. Most of the
rice is moving from Java to Sulawesi, where rice is easily smuggled
to the Philippines. Incomes outside of Java have increased in
response to increased investment in non-food commodities and palm
oil, according to local analysts.

Supply
------

8. (SBU) Production of palm oil, rubber, coal, and metals has
increased in Indonesia in response to higher prices. Food
production has been slower to respond. The GOI has failed to
meaningfully invest in the agriculture sector over the past decade,
resulting in deterioration in agriculture productivity. Experts
note that Indonesia's fertilizer and seed technology is 30-40 years
old, while irrigation systems continue to age without funds for
repair. Indonesia may also lose as much as 30 percent of its
harvest in the transition from farm to market due to antiquated
harvesting techniques. Land use restrictions also severely limit
the size of farms, inhibiting expanded production. The lack of
investment in roads and transportation systems in Indonesia limits
farmer's access to markets and their ability to respond to higher
prices.

9. (SBU) Indonesia's fuel and electricity subsidy scheme also
restricts the amount of money available to invest in agriculture
infrastructure or provide shorter term assistance to the poor. If
oil prices remain near $100 per barrel, Indonesian could spend as
much as $25 billion (roughly 25 percent of the budget) on subsidies
this year. Despite these problems, experts expect rice production
to be higher this year due to better weather conditions.

Political Impact
----------------

10. (SBU) There have been numerous protests against rising food
prices in recent months, but none have been violent. The level of
dissatisfaction with the current government is rapidly rising, but
the President remains the front runner in the 2009 Presidential
elections at this time. Food price increases in Indonesia to date
are concentrated in soybeans, wheat, and palm oil, which comprise a
considerably smaller portion of the average Indonesian diet compared
with rice. Public dissatisfaction with the government is likely to
rise significantly if rice prices begin to increase at a rapid pace.
In a sign that food prices have already had an impact on poor

JAKARTA 00000868 003 OF 005


household budgets, government stocks of low cost, poor quality rice
have declined significantly in recent months. (Note: For additional
political analysis please see Jakarta 684. End note.)

Economic Impact
---------------
11. (SBU) The rise in food prices has already translated into higher
overall inflation in Indonesia. The CPI inflation rate jumped to
8.2% (YoY) in March, well outside the central bank's 4-6% target
range. Some analysts predict the rate could rise as high as 10%
before the end of the year. The GOI's 2008 GDP growth projection of
6.4% is now well above most market forecasts, due to disparate views
between the GOI and analysts on domestic demand and investment
rates. The government projection is based a continuation of current
domestic demand and investment trends, and only a modest decline in
net exports. However, market analysts note that soaring food prices
and low job growth have reduced consumer confidence, which is now at
a two year low. If inflation rates remain high, Bank Indonesia (BI)
will also need to raise interest rates, which could significantly
slow consumer finance and investment.

12. (SBU) On the external side, most analysts expect Indonesian
exports to continue to benefit from high commodity prices, but
predict Indonesian manufacturing exports will decline this year in
response to flagging demand in Japan and the United States. Some
GOI advisors have also stated that BI plans to actively maintain or
increase the value of the Rupiah in an effort to limit imported
inflation, a move that could hurt Indonesian exporters. The cost of
imported food and commodity-based finished products are also likely
to lift the import bill this year, potentially reducing the trade
balance.

13. (SBU) The expected slowdown in manufacturing exports will also
disproportionately impact jobs, potentially increasing the number
people vulnerable to poverty. Every $1 billion in manufacturing
exports creates 242,000 jobs, whereas the same amount of exports of
coal, mining, or chemical products create only 12,000, 43,000, and
8,000 jobs, respectively, according to research study by Chatib
Basri of University of Indonesia and Gustav Papanek of Boston
University. The same study notes there have been no new jobs
produced among large and medium firms in Indonesian in the last ten
years because of stagnant growth in job-creating export sectors such
as manufacturing. Yet 20 million people have joined the workforce
since 1997. Most of these people are currently underemployed in the
agriculture sector, living on very low wages and remaining extremely
susceptible to poverty, according to Basri and Papanek.

14. (SBU) Analysts note that investors are increasingly worried
about the ability of the GOI to control the budget in light of
rising food and oil prices, underscoring the importance of prudent
policy making in the current environment. According to government
officials, the President plans to approve a 25% increase in the
price of subsidized fuel and kerosene in the next week, in an effort
to increase fiscal space to deal with the food crisis. Analysts
link the move to growing market concerns about the size of the
subsidy bill. (see septel) Markets declined sharply in April in
response to worries that the fuel subsidy regime presents an
unlimited liability to the government. The Indonesia Stock Exchange
index fell 7.1% within the first week of April and the yield on
5-year Indonesian Rupiah government bonds rose to 11.6% from 10.4%
over that same period, according to a recent Standard Chartered
Report.

15. (SBU) Financial markets are also nervous about inflationary
pressure in Indonesia. A recent report from HSBC cites Indonesia
(along with Vietnam) as the most "behind the curve" in terms of
fighting inflation, due to monetary policy loosening in 2007.
Reducing the fuel subsidy may increase inflation by as much a 3
percentage points, according to HSBC analysts. Six months ago
financial analysts expected the Indonesian economic growth to run
close to 7.0% in 2008, on higher investment, domestic consumption,
and strong exports. Analysts now worry that the need to

JAKARTA 00000868 004 OF 005


aggressively fight inflation and slowing world demand will push
Indonesia's growth rate below 6.0%, with limited potential for new
job creation or poverty alleviation.

Environmental Impact
--------------------
16. (SBU) Rising CPO prices have accelerated the growth of oil palm
plantations throughout Indonesia, particularly in Kalimantan, and
added to pressures for significant expansion in Papua. This
expansion in acreage is often linked to deforestation, as companies
or individuals clear forested land to plant oil palm -- a more
profitable tactic than planting on existing non-forested land, which
entails foregoing a quick return from the harvested timber. At
times, land owners fail to plant cleared land with oil palm, leading
to deterioration of water catchment areas and increasing runoff.
Anecdotal evidence does not suggest any similar large-scale trend
with farmers clearing land to plant rice or other commodity food
crops, though, in the past, encroachment and coffee planting in
national parks in Sumatra was associated with increases in the price
of coffee.

Government Policy Response
-------------------------
17. (SBU) On February 4, Deputy Chief for Coordination of
Agriculture and Marine Resources Bayu Krisnamurthi announced a host
of new and ongoing policies designed to stabilize food prices. GOI
policies to respond to the food crisis center on increased subsidies
and revised trade policies rather than longer term investments in
agriculture. The policies include soybean price subsidies for
small-scale producers (Rp 1,000 per kg), which has not yet been
implemented, 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. 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 accelerate the
provision of high quality seeds and promote the development of wheat
alternatives.

18. (SBU) The GOI has focused more recent policies on rice. The GOI
banned rice exports of rice by anyone except the state-owned Bureau
of Logistics (BULOG). The GOI also raised the price of rice that
BULOG pays to farmers by 10 percent to 2200 Rupiah per kg.
According to officials from the Ministry of Finance, the GOI also
plans to announce a cash transfer to poor households in the coming
weeks, to offset the impact of rising food prices and fuel prices.
The GOI has not announced large scale plans to improve
infrastructure or reduce inefficiencies in the agriculture sector.
According to press reports, the President recently accepted a
proposal by the Indonesian Chamber of Commerce (KADIN) to establish
a committee to streamline regulations and reduce bureaucratic
requirements for investment in the commodities and agriculture
sector. However, it remains unclear if this committee will be an
effective means of attracting investment to the sector.

Impact of Post Programs
-----------------------
19. (U) USAID established the Agribusiness Market and Support
Activity (AMARTA) project to increase productivity, improve quality
and expand access to markets for Indonesia's agribusiness
stakeholders. As a result of the increased worldwide demand for
rice, the AMARTA program has established a pilot project in the
village of Agimuga, Papua. This project will provide technical
training for good agriculture practices for rice planting and
harvesting. It will also provide suitable seeds and technical
assistance on pest control in order to increase production of this
staple.


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Policy Proposals
----------------
20. (SBU) Post recommends the GOI take a comprehensive approach to
the food price issue by 1) providing cash transfers to the poor to
increase purchasing power (rather than imposing price controls); 2)
increasing investment in agriculture infrastructure and extension
services and reducing restrictions on land and seed use to allow
farmers to respond to higher prices; and 3) encouraging investment
in labor-intensive manufacturing to increase job growth and reduce
the incidence of poverty in Indonesia. Post also recommends the US
and Indonesia work with ASEAN and other Asian nations to discourage
rice hoarding and correct the current distortions in the world rice
market.

HUME

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