IF A TREE FALLS IN A FOREST, WHO HAS THE EXPORT RIGHTS?

MARCH 10, 1999--IF A TREE FALLS IN A FOREST, WHO HAS THE EXPORT RIGHTS? INDONESIAN FORESTRY REGULATIONS, 1999
SUMMARY

1. The economic turmoil of 1997 and 1998 and the end of the Soeharto government have forced fundamental changes on Indonesia's forestry industry. Indonesia's 1997 IMF agreement mandated the termination of many restrictive practices that protected favored conglomerates and distribution networks. As Indonesia works toward a replacement forestry sector policy, a new theme has emerged: the transfer of forestry resources to communities, collectives, and small enterprises. As the old system is being challenged, two concerns have arisen about the new: first, will the insertion of collectives prove viable? and, second, are environmental considerations being sidelined? How Indonesia addresses both issues will have important consequences for the long-term viability of Indonesia's forests and the efficacy of reforms. End Summary.
CONGLOMERATES DOMINATE FORESTRY SECTOR

2. The Indonesian constitution stipulates that all natural resources in the country are owned by the state and the Indonesian government thus controls the allocation of all such resources. The government began awarding twenty-year concessions for forest exploitation (Hak Pengusahaan Hutan or HPH) in 1971, but no clear regulations on the bidding process were ever put forward decision-making lay with President Soeharto. A few conglomerates ended up with the majority of the permits. Official figures show that as of 1998, 34 business groups controlled 50 percent of legal concessions, totalling nearly 25 million hectares.

3. Besides holding rights to the majority of timber concessions, conglomerates controlled the industry through vertical integration. For example, sawmills and other processors were obliged to sign a contract with a forest concession guaranteeing log purchases in order to receive operating licenses. The conglomerates also owned the roads and transshipment facilities required to get the sawn timber to factories and charged independent producers high fees for their use. The result was many smaller operators were squeezed out and the concessions ran most of the processing.
BAN ON EXPORTS THE KEY POLICY

4. The policy keystone of the New Order forestry policy was the ban on log exports, introduced in 1980 through Ministry of Forestry Decree No. 317/1980 but not put in

force until 1985. Up to that time, the industry had mostly involved the cutting and export of logs and timber. The ban aimed to create an integrated wood processing industry that would capture more value-added for domestic companies, create jobs, and ensure sound resource management. In May 1992, in order to comply with GATT regulations, the ban was revoked (Ministry of Finance Decree No. 534/1992) and replaced by a prohibitive export tax of between US$500 and $4,800 per cubic meter depending on the type of wood. Similar tariffs were applied to the export of sawn timber and other semi-finished products as well.

5. Exports of raw rattan were formally banned in 1979 and in 1982 minimally processed rattan was subjected to a 20 percent export tariff as well, but neither policy was fully enforced until 1986. As with logs and timber, these policies were designed to cultivate and protect a domestic downstream industry. In October 1986, Ministry of Industry and Trade Decree SK 274/1986 divided rattan products into three basic categories: raw, semi-processed, and finished. More products were categorized as raw and thus subject to the export ban. Semi-processed rattan was made subject to a 30 percent export tax that was replaced with a total export ban in 1989. Only products defined as finished were free of export restrictions. This policy remained until 1992, when these restrictions were lifted in favor of an export tax of $10-15 per kilogram for semi-finished and raw rattan, respectively.
CONCESSIONS SUBJECT TO LEVIES, PERFORMANCE REVIEWS

6. Concession holders were required to pay numerous levies as part of their agreements. These included a levy on forest products (Iuran Hasil Hutan, or IHH, based on the value of what they extracted from the concessions), reforestation fees, and other taxes. The fees were intended to finance replanting, forest maintenance, and government oversight. Additionally, performance of the concessions could be reviewed by the government at any time during the lease period. Firms whose productivity or adherence to environmental standards were judged to be too low could be fined, have their production quotas cut, or lose their concessions. Government statistics show that between 1988 and 1998, fines totalled tens of billions of rupiah and 86 concession holders had permits revoked.
INDUSTRY ASSOCIATIONS CONTROL THE MARKET

7. As part of the overall plan to control exports, the wood products industry was organized into industry organizations and marketing boards. Market access and exports were controlled by the boards, which allocated market share. Policy decisions were made by industry associations and approved by the relevant ministries. Membership in these organizations was mandatory and members were required to pay annual fees to finance the marketing boards' expenses and promotion efforts. All of the associations were controlled by Bob Hasan, a Soeharto business partner and owner of one of the largest forestry conglomerates. Hasan, who was an architect of the export-oriented system, through control of these organizations and ties to Soeharto, was for years the most powerful man in the industry.


POLICIES SUCCESSFUL, BUT AT A COST

8. The system did achieve its goal of reducing (legal) exports of unfinished wood and rattan to near zero and capturing more of the industry's value-added through the nurturing of downstream industries. While these policies assured the domestic woodworking industry a steady supply of cheap raw materials and encouraged the development of downstream industries, there were externalities. Sawn timber production generated higher value-added and more employment than plywood, but was marginalized by the export bans. Inefficient but favored companies with deep pockets and political influence ran their operations with little or no regulatory oversight. Trees were harvested as quickly and cheaply as possible with few environmental safeguards. Illegal logging flourished with the complicity of local officials. Additionally, Java, where the large companies have their headquarters and the furniture and rattan factories are concentrated, benefitted disproportionally at the expense of the outer provinces who produced the raw materials but lost much of the downstream processing.
THE IMF AGREEMENT STRIKES THE FIRST BLOW: THE END OF THE EXPORT TAXES

9. Under its 1997-2000 economic reform program supported by the IMF, Indonesia committed to change its forestry sector regime. A key provision called for phasing out the export tariffs on logs, sawn timber, and rattan. The export tax was reduced to 30 percent in an April 1998 Finance Ministry decree and was scheduled to go down to 20 percent as of December 31, 1998. However, the change has not yet taken place. Sources say the Ministry of Forestry has approved in principle and it is now up to the Ministry of Industry and Trade to approve the changes. The 20 percent rate is currently scheduled to go into effect in March. According to the schedule agreed to with the IMF, the export tax rates are slated to be reduced again to 15 percent by the end of 1999 and to 10 percent by the end of 2000.
OTHER EXPORTS RESTRICTIONS ALSO ELIMINATED

10. Although the export tax reduction scheduled for December 1998 remains in limbo, other export restrictions on forest products, including logs, timber, and rattan, have been officially eliminated. Minister of Forestry and Plantations Decree 510/1998, enacted in July, allows for the export of logs with a minimum diameter of 30 cm for most types of wood. Combined with the lifting of the export tax, this is expected to open new markets for the concession holders.

11. Industry representatives, both from downstream users and concessionaires, worry about a shortage of logs for the domestic industry. The government has said that, despite reduced demand for plywood and other finished products from Indonesia's Asian trading partners, processors are facing a shortage of logs. The Ministry of Forestry estimates that domestic processors' capacity is 57 million cubic meters of wood, but the country's supply last year was less than 46 million cubic meters.

12. Exports do not seem to be the problem, however. The distribution network for logs is underdeveloped and the Asian market is sluggish. Indonesia's reported log exports are small, 114,000 cubic meters for January and February 1999, and the government projects only 860,000 cubic meters in exports for the entire year. Rather, the Ministry of Forestry attributes the shortage of available timber to lower domestic production of timber resulting from bad weather and too many processing firms chasing too few resources. The result is sawmills are currently operating at less than 50 percent of capacity.
A NEW FOREST RESOURCES LEVY

13. A "Forest Resources Royalty" (PSDH) officially replaced the old levy system (IHH) in April 1998. The changes were enacted through Presidential Decree 67/1998, Government Decree 51/1998, and Decree of the Minister of Industry and Trade 258/1998, which set the royalty reference prices. Under the new system, the concession holders are responsible for paying a royalty on every log harvested. The royalty, which will be calculated every 3 to 6 months, is set at 1 to 6 percent of the international market prices for the logs. Logs with diameters in excess of 30 cm, tropical woods such as teak, ebony, and sandalwood, and large-diameter rattan are subject to the 6 percent rate. Pine, acacia, balsa and other woods from industrial forests will be assessed a 5 percent levy. The royalty on logs not otherwise specified with diameters less than 30 cm will be 1 percent of their value.

14. As of December 31, 1998, rights holders were to be required to put up performance bonds based on the assessed value of the concession to ensure they pay the new resources royalty. This new requirement has been delayed while the Ministry of Forestry drafts the implementing regulations. The hope is that requiring payment for each log cut, and holding a bond to guarantee the payment, will remove the economic incentive to maximize extraction and encourage sustainability and better resource allocation. Adherence by the concessions is to be verified though independent inspections.


MISUSE OF FORESTRY FEES UNDER INVESTIGATION

15. While tens of billions of rupiah were collected from concession holders for reforestation, much of the money is unaccounted for. The questionable use of these fees put them at the top of anti-corruption activists' list of irregularities to be investigated. In the most recent example, the Minister of Forests and Plantations, Muslimin Nasution, announced the withdrawal of two presidential decrees that granted reforestation funds valued at 250 billion rupiah ($33 million) to a paper company and a bank. As part of Indonesia's reform program agreed with the IMF, foreign auditors will examine the use of the reforestation funds and are scheduled to finish their work this June.
PLYWOOD MARKETING ORGANIZATION DECLAWED

16. Another major change is the removal of restrictive marketing arrangements for many forest products. Most notably, the privileges enjoyed by APKINDO, the plywood association, were removed by decrees of the Ministry of Industry and Trade. APKINDO, formerly the most powerful of the industry organizations, still exists, but under new leadership as a voluntary industry association with no formal powers. Its new functions include collecting industry statistics, representing producers in discussions with the government, and serving as a forum for marketing the industry abroad.

17. Plywood producers have been hurt by decreasing exports to other Asian nations, their largest customers, as a result of the current economic crisis. Recent reports on timber exports show that Indonesian plywood production fell by 37 percent from 1996 to 1997 and fell again, slightly, in 1998. Despite its difficulties, the industry still employs nearly half a million people and plywood accounts for around half of the value of Indonesia's forestry exports. Once the crisis abates, industry representatives expect demand from long-time Asian customers to recover quickly. Meanwhile they are seeking new markets for their exports.
RATTAN SLIPS IN IMPORTANCE

18. Producers of finished rattan are organized into a marketing group, known as ASMINDO, originally under the direction of Bob Hasan. It, too, has new leadership and has changed its role to one of traditional industry promotion and public relations.

19. Rattan, though, has other difficulties. Through the 1970's and early 1980's, Indonesia was the world's largest exporter of raw and semi-finished rattan, with approximately 80 percent of the world market. Rattan is grown largely in Sulawesi and Kalimantan by small, locally-based producers. Rattan plantations, the largest of which encompass fewer than 1000 hectares, are secondary producers. As plywood and other forest products became more important, traditional rattan growing areas were cleared for more valuable crops, including palm oil and timber. (In one notorious example that went on for years, the government planned to strip one million hectares of rattan-producing land in Central Kalimantan to set up a rice plantation on land that was universally assessed to be unsuitable for rice production. The transformation was recently halted after technical and financial problems arose.) Almost immediately after the export ban was implemented the Indonesian rattan industry saw its world market share decline as countries such as the Philippines filled the demand for raw and semi-processed rattan, much of which was smuggled in from Indonesia.

20. Today the Indonesian rattan industry, while still viable and responsible for a large percentage of the world's production of rattan furniture, is far less significant that it was twenty years ago. This is due to increased competition, lower prices on the world market, and higher value segments of the Indonesian wood-products industry which have taken resources away from rattan production.
NEW LIMITS ON SIZE OF FOREST CONCESSIONS

21. Along with the ending of export restrictions, other new regulations indicate that government support is swinging away from conglomerates. Such a transition would represent a seachange for the industry. One key regulation, published first in Decree of the Minister of Forestry and Plantations (SK Menhutbun) No. 728 of 1998 and then again in the new forestry regulation, Presidential Decree (PP) No. 6/1999, limits the size of forest concessions controlled by a single individual or conglomerate. The new restrictions, which are retroactive, limit permit-holders to 100,000 hectares in a given province, except for Irian Jaya where the maximum is 200,000, and to a total of 400,000 hectares across Indonesia. This decree could affect the fifteen largest forestry groups who control multiple concessions totalling over 500,000 hectares.
DOWNSTREAM USERS NOT TIED TO CONCESSION HOLDERS

22. Another regulation affecting the conglomerates addresses the access of downstream manufacturers to raw materials. In the past, the concession holders controlled much of the industry, from the plantations through sawing and export. Minister of Forests and Plantations Decree No. 620/1998, "The Form of Ownership and Interrelation of HPH and IPKH" replaced No. 684/1993, which mandated that processors have agreements with concessions in order to operate. Sawmills and factory owners are supportive of this new regulation, which will allow them to negotiate freely for raw materials in search of the best deal. The delinking of the sawmills and the concessions was one of the prerequisites for the disbursement of a World Bank loan.
OPEN BIDDING ON CONCESSIONS?

23. The new presidential decree, PP 6/1999, also opens concessions to competitive bidding. This decree begins the process of establishing new procedures for bidding on forestry concessions, including provision for opening bids to public tenders for the first time. This represents the first time forestry concessions have been truly open to multiple bidders and was a key criterion of the World Bank loan.

24. The government has indicated the first auction of concessions will take place in March 1999. The exact format of the auctions is still awaiting implementing regulations, but the Ministry of Forests and Plantations has outlined some of the proposed procedures. These include the bidders' demonstrating financial soundness, having expertise in forestry, and providing bank guarantees for their reforestation deposits. The government is using a scoring system to pick the winners that would favor companies with local employees in management positions.
QUESTIONS SURROUND THE NEW REGULATIONS

25. The new system is largely untested and uncertainties thus abound. Industry sources say there are potential problems with the new forest levy/performance bond system. They and independent sources claim that data collection in Indonesia is not good enough to calculate the value of a concession ahead of time and thus the tax burden and the size of the bond, which is linked to the concession's value, will be unknown until after a concession is auctioned. They also pointed out that tax collection, frequently negotiable in Indonesia, is based on net profits, which are often difficult for government officials to assess.

26. The government's commitment to opening up exports is also limited. Besides its tardiness in approving the scheduled reduction in the export tax, the Ministry of Industry and Trade has authorized the Ministry of Forestry and Plantations to set a national export limit on some forest products. These limits are designed to ensure a domestic supply of raw materials and protect national resources. Moreover, only concession rights holders are permitted to export.

27. There are also doubts related to the regulation freeing the downstream manufacturers from the concession holders. Experts in Indonesian forestry policy point out that the wording of the decree is vague and it is not clear what enforcement mechanisms the government will use to ensure the sawmills' independence from the HPH holders. Moreover, the sawmills are often geographically isolated, thus tied to the concessions they were built on or near. Roads linking them to different concessions, which would be necessary to bring in logs from outside, are limited and in poor condition. Given the vagaries of the law and simple logistics, it is difficult to guarantee downstream users and concession holders can be liberated by decree.

28. The new system also does little to address illegal logging, either in the form of overcutting by legal concession holders or extraction from protected areas by independent operators. The best estimates are that amount of timber illegally extracted is equal to the amount legally harvested. With little accurate data as to the actual makeup of a given concession, monitors will be hard-pressed to evaluate if a concession has been illegally logged. Moreover, if local officials are influenced to ignore the practice, the capture and prosecution of illegal loggers will continue to be almost impossible.

29. Reactions to the directive limiting conglomerate size have been mixed. The local press reports the chairman of the Association of Indonesian Forest Concessionaires as saying the move would allow common people to benefit from the resources and to reduce resentment toward the HPH holders. In an opposing view, the chairman of APKINDO was quoted as saying the wood-processing industry would suffer from a lack of logs as the concessions will no longer be industries of scale.

A representative of the Indonesian Sawmill and Woodworking Association said it is not concession size, but rather government restrictions on the amount that can be cut from each concession that determines the supply for downstream industries.

30. All the industry sources agree the process for breaking up the large holdings is unclear and questions abound. Who will decide what portion of the concessions will be taken away from the current rights holders? How will they make the decision? Will the current concession holders be allowed to maintain the rights to the land until their permits expire? These and other key details are yet to be worked out, leaving the industry in state of uncertainty.
COOPERATIVES TO FILL THE VOID

31. One new policy has been made eminently clear. To end the domination of the forestry industry by conglomerates, the government has stipulated that forestry resources be redistributed to local cooperatives. This is part of a broader movement promoting a "people's economy." With forestry products one of the largest industries in Indonesia, and the first natural-resource industry to be targeted, such policies may be indicative of how future reforms will proceed.

32. The most sweeping of the new cooperative-oriented regulations in the forestry industry was issued November 10, 1998 by Minister of Forestry, SK Menhutbun 732. Under this regulation, concession holders must give between 10 and 20 percent of their shares to cooperatives. Additionally, each year of the concession permit's validity the cooperatives will have the option of buying another 1 percent stake. With a 35-year lease on the land, this would give a cooperative the opportunity to control up to 55 percent of a concession. The cooperatives are not to utilize the shares by working the land independently, but rather to take a role in management and receive a percentage of the company's profits. The implementing regulations, with the specifics of how the redistribution will occur and the obligations of the parties, have not yet been issued.
NEW PROGRAM FOR COMMUNITY MANAGEMENT

33. Another recent pro-cooperative policy was the creation in October 1998 of a new type of forestry permit, the "Rights for Exploitation of Community Based Forests" (HPHKM) (SK Menhutbun NO. 677/1998). Under this regulation, a community, working through a local cooperative, may submit an application to the Provincial Office of the Ministry of Forestry and Plantations for exploitation rights of State forest areas "around their dwelling place(s)". The rights, once granted, are good for thirty-five years.
IS THE CO-OP MODEL VIABLE?

34. Reactions toward the shift in policy are mixed. Some observers of the industry say, if implemented properly, these policies could represent a real change in terms of local communities benefitting from natural resources in their area. A representative of the sawmill industry said his companies will not actively oppose this change because they have no choice in the matter; this is simply the direction in which things are headed and it must be dealt with. He was hopeful that acceptable agreements could be reached with the cooperatives.

35. In contrast, a representative of the concession holders was more resistant to the plan, pointing out that it would be difficult for investors to justify bidding on a concession in which they might eventually lose their majority stakes. This could lead to low auction values, reducing income to the Indonesian government. Likewise, some have questioned how cooperatives would get the funds to pay for such investments and what their actual role in management would be. Observers have pointed to the cooperatives' lack of a proven management track record and deficit in technical expertise. Others have raised questions about the cooperatives' independence, expressing concerns that they will function as holding companies for concessionaires seeking to skirt the 400,000 hectare limit. Despite such concerns, the government has emphasized its support for the cooperative model.
EFFECTIVE ENVIRONMENTAL MANAGEMENT STILL LACKING

36. With all the reforms that are taking place, the Indonesian government has taken little action recently to address environmental and sustainability concerns. The UN Intergovernmental Panel on Forests (IPF), which completed a report on Indonesia's forests and forestry industry in April 1998, concluded that there was a low level of professional management, a lack of awareness of sustainability, and in many cases short-term cash flow concerns that took priority over sustainability.

37. A separate study commissioned by the Indonesian National Development Planning Board (Bappenas) that was completed in October 1998 came to much the same conclusion. The study, entitled "Natural Resource Impacts of Indonesia's Financial Crisis", noted that official log extraction increased by about 10 percent in FY 97/98 to approximately 29 million cubic meters, whereas the level of sustainability was estimated at 22 million cubic meters. Unofficial estimates (i.e., numbers that include illegal cutting) put the real rate of log extraction at nearly double the government and industry figures.
EXPANDING PULP AND PAPER INDUSTRY ADDS TO CONCERNS

38. Lower cutting rates are nowhere in sight, either. Whereas plywood production may be down, log extraction for pulp and paper, a resource-intense industry, has doubled since 1994/95. Current industry projections indicate the pulp and paper industry may earn nearly 45 percent of all export earnings for the wood and wood products industry for 1998. The most recent expansion of the pulp supply took place in November of 1998, when the Ministry of Forestry and Plantations issued permits for the opening of 13 special industrial timber estates (HTI), covering 3.3 million hectares, exclusively for pulp production. There are additional concerns that non-industrial forests may be getting cut for pulp production, a trend that could further accelerate deforestation.
NEED FOR ADHERENCE TO ENVIRONMENTAL STANDARDS

39. Until recently the forest products industry was able to disregard calls for tighter environmental controls. Decreased demand from Asian customers has made the EU, North America, and Australia/New Zealand, where environmental awareness is high, relatively more important. The Indonesian government has taken some steps that begin to address environmental concerns and producers are now making moves toward modern environmental management.
CONCESSION LENGTH EXTENDED TO 35 YEARS

40. As part of the new forestry regulation (PP No.6/ 1999), the validity of concession rights was extended to 20 years plus 35 years for reforestation, for a total length of 55 years. Under the previous, flat 20-year system, the concession holders had no incentive to participate in reforestation schemes or limit log extraction, since there was no guarantee they would still have the concession when newly planted trees matured. It is hoped that 35-year rights will provide concessionaires an economic incentive to maintain the viability of their holdings.
DECENTRALIZATION AS AN ENVIRONMENTAL SAFEGUARD?

41. Another approach to environmental management may come under the guise of regional autonomy, an emerging trend in post-Soeharto Indonesia. Government regulation (PP) No. 62/1998 moves toward decentralizing administrative control of some forestry resources. This regulation authorizes the provincial and district (sub-provincial) governments to assume specific responsibilities from the central government. These new duties include land and air conservation, forestry protection, responsibility for some forest reserves, and management of non-wood forest crops. The hope is that, given their proximity to the communities that rely on the forests, provincial and district officials could prove more sensitive to environmental issues. NGO representatives stress the key issue will be accountability of the provincial governments. Without this, mismanagement could simply pass down to the provincial level.
ADHERENCE TO INTERNATIONAL STANDARDS

42. Adherence to internationally recognized environmental standards is an area Indonesia has started to address. Many countries now have ecolabeling requirements for forestry products and Indonesian producers risk losing market share, or even boycotts, if they do not move toward greater environmental protection. Industry sources have said they intend to be in compliance with the International Tropical Timber Organization guidelines on sustainability, signed in 1994, which commit Indonesia to meet specific standards by the year 2000. Additionally, there is an idea within the industry of creating an Indonesian environmental certification stringent enough to avoid environmentally-based sanctions or prohibitions on exports.

43. Local environmental sources worry that the economic crisis will reduce the chances of implementing stringent environmental controls. The weak market means the industry seeks to minimize costs while maximizing production, the government does not have the resources to pay for enforcement, and cooperatives do not have the necessary environmental expertise. Introducing and enforcing strict environmental standards is a process that could take years.

Source: us embassy