IMPLEMENTATION COMPLETION REPORT

Transcription

1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Report No Public Disclosure Authorized IMPLEMENTATION COMPLETION REPORT INDONESIA Public Disclosure Authorized FERTILIZER SECTOR RESTRUCTURING PROJECT (LOAN 3282-IND) June Public Disclosure Authorized Private Sector Development Unit East Asia and Pacific Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EQUIVALENTS Currency Unit = Indonesia Rupiah (Rp) Appraisal Report US$1 Rp 1,830 ICR (Dec 1997) US$1 =Rp 5,000 FISCAL YEAR April 1 - March 31 AS - Ammonium Sulfate Ekku Wasbang - WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS Coordinating Ministry for Economic, Finance and Development Supervision FSP - Fertilizer Sector Policies Gresik - PT Petrokimia Gresik, Gresik ICR - Implementation Completion Report Kaltim - PT Pupuk Kalimantan Timur, Bontang Kujang - PT Pupuk Kujang, Cikampek MOA - Ministry of Agriculture MOIT - Ministry of Industry and Trade PFC - Participating Fertilizer Company PIM - PT Pupuk Iskandar Muda, Aceh Pusri - PT Pupuk Sriwijaya, Palembang SAR - Staff Appraisal Report tpd - Tons per Day tpy - Tons per Year TSP - Triple Superphosphate Vice President Country Director Sector Manager Task Manager Jean-Michel Severino, EAPVP Dennis N. de Tray, EACIF Hoon Mok Chung, EASPS Kunrat Wirasubrata, Operations Officer, EACIF

3 FOR OFFICIAL USE ONLY CONTENTS PREFACE. iii EVALUATION SUMMARY. v PART I: PROJECT IMPLEMENTATION ASSESSMENT... I A. Project Objectives and Description... 1 B. Achievement of Project Objectives... 2 C. Implementation Record and Major Factors Affecting the Project...6 D. Project Sustainability... 6 E. Bank Performance... 7 F. Borrower Performance... 7 G. Assessment of Outcome... 8 H. Future Operations Key Lessons Learned... 8 PART II: STATISTICAL TABLES Table 1: Summary of Assessments Table 2: Related Bank Loans/Credits. 1 Table 3: Project Timetable. I I Table 4: Loan/Credit Disbursement: Cumulative Estimated and Actual. 1' Table 5: Key Indicators for Project Implementation.12 Table 6: Key Indicators For Project Operations.12 Table 7: Studies included in Project.13 Table 8a: Project Costs Table 8b: Project Financing Table 9: Economic Costs and Benefits...,,.,,.,. 14 Table 10: Status of Legal Covenants Table 11: Compliance with Operational Manual Statements Table 12: Bank Resources: Staff Inputs Table 13: Bank Resources: Missions ANNEX A: ICR MISSION'S AIDE MEMOIRE ANNEX B: BORROWER'S COMMENTS ON THE ICR This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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5 - III - IMPLEMENTATION COMPLETION REPORT INDONESIA FERTILIZER RESTRUCTURING PROJECT (LOAN 3282-IND) PREFACE This is the Implementation Completion Report (ICR) for the Fertilizer Restructuring Project in Indonesia, for which Loan 3282-IND in the amount of US$221.7 million equivalent was approved on December 20, 1990 and made effective on March 26, The loan was closed on December 31, Final disbursement took place on October 8, A balance of US$6,526,911 was canceled as of December 31, The ICR was prepared by Kunrat Wirasubrata (Operations Officer/Task Team Leader, EACIF), with contributions from Kurt M. Constant (Senior Industrial Specialist, IENIM), Thomas Walton (Senior Environment Specialist, EACIF) and Unggul Suprayitno (Financial Analyst, EACIF). Hoon Mok Chung, Sector Manager, Private Sector Development Unit, EAP reviewed the report. Preparation of this ICR, which began during the Bank's final supervision mission in October 1997, was based on materials in the project file. The Government commented on the draft but did not prepare a separate evaluation.

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7 - v - INDONESIA FERTILIZER RESTRUCTURING PROJECT (LOAN 3282-IND) EVALUATION SUMMARY Introduction 1. The Fertilizer Sector Restructuring Project (the Project), for which this Implementation Completion Report (ICR) is prepared, was designed based on the Bank's fertilizer sector work in This is the last in a series of Bank-supported projects in the Indonesian fertilizer sector that began in The fertilizer industry in Indonesia is characterized by highly administered feed stock and product prices, an inefficient distribution system and excessive end-user consumption, which had led to the industry's potential being not optimally cultivated. To address this issue, the Government had in 1990 produced a Statement of Fertilizer Sector Policies aiming at improved sector efficiency and performance. Project Objectives 3. The Project's objectives were: (a) to assist the Government in implementing the Statement of Fertilizer Sector Policies (FSPs), which focused on adjustment of fertilizer prices to reflect their economic prices, leading to gradual elimination of the associated subsidy payments from the government budget; (b) identify the scope for improved efficiency in marketing and distribution; (c) assess the industry's environmental impact and standards, and prepare an environmental management program; and (d) support an industry-wide investment program. 4. With the first objective, the Government was responding to the need for sustainable sector restructuring to improve overall efficiency of the industry. With the second objective, the Government sought to identify options and scope to improve efficiency of fertilizer distribution. The remaining two objectives were necessary to improve technical efficiency and productivity of Indonesian fertilizer sector as well as increase production capacity. Five of six state-owned fertilizer companies (PT Pupuk Iskandar Muda, PT Pusri. PT Pupuk Kujang, PT Petrokimia Gresik, and PT Pupuk Kalimantan Timur) participated in the Project. PT ASEAN Aceh fertilizer, owned by the ASEAN countries, did not participate. Implementation Experience and Results 5. Fertilizer Sector Policies. The Government has partially adjusted the price of gas inputs and regularly adjusts that of urea. Price control on phosphate and ammonium

8 -vi - sulfate fertilizers has also been removed completely. These have resulted in significant reduction of budgetary subsidy by almost 60 percent from Rp 457 billion in FY92/93 to Rp 195 billion in FY96/97'. 6. Limited improvements made in the marketing and distribution system have not fully realized the potential gain if the system is fully restructured. The Government's reluctance to restructure is due to its desire to make fertilizer products available throughout the country at uniform prices. Ironically, despite the efforts to enhance up-stream and distribution efficiencies, farmers continue to apply fertilizer excessively. A study commissioned under the project indicated excess fertilizer application in Java to be in the range of 20 to 30 percent. Also, the Ministry of Agriculture (MOA) prepared a fertilizer demand projection, which determines annual production volume, that continues to be historically based by applying a certain percentage of annual increase rather than based on systematic individual soil analyses. 7. Despite these accomplishments, as the adjustments continue to be initiated and administered by the Government, the sector remains heavily regulated with its structural inefficiencies. Furthermore, the FSP had failed to address more fundamental issues such as introduction of competition within the sector and full sector deregulation. Viewed from this perspective, the FSP was inadequately designed to result in improved overall economic efficiency. 8. Industry-wide Investment and Environmental Program. All objectives related to the industry-wide investment program and application of environmental standards have been satisfactorily achieved. A new ammonia and urea plant in Gresik, adding about 460,000 tons per year (tpy) of urea to the country's production capacity, has been on-stream since 1994 and modernization of Gresik's phosphate fertilizer plants were completed in 1996 with satisfactory results. Energy consumption per ton of ammonia/ urea produced in five optimized plants has been reduced, environmental standards for the fertilizer industry have been established, and an effective environmental management program is already in place in all participating fertilizer companies. The long experience of the participating fertilizer companies (PFCs) in constructing and operating ammonia/urea plants is a factor critical to the successful implementation of the investment program. However, the project's rates of return are lower than appraisal estimates due to lower export prices and assumed higher price of gas input (US$2/mmbtu). Lower export prices also has led to unfavorable financial condition of the PFCs. 9. Implementation Experience. Except for international fertilizer prices, all other factors necessary to warrant a successful implementation were basically within the control of the Government. This is shown by the satisfactory implementation of the However. draftic devaluation of the Rupiah against the USR has dramatically increased production cost and forced the Government to re-introduce subsidy for these products (SP36 and AS) in April 1998.

9 - vii - physical investment program. In implementing the FSP, however, its broad institutional implication appears to have been inadequately addressed, as indicated by the absence of a strong leadership agency to provide and direct formulation and implementation of the policies. Toward the end of implementation, this shortcoming appears to have been addressed through establishment of a Holding company, chaired by PT Pusri, with a mandate to further improve sector efficiency, set the stage for privatization of the PFCs, and prepare the sector for full deregulation in early 2000s. Although it is not necessarily the ideal solution, if it has full support from the Government, is professionally managed, and is consistently directed toward realizing overall sector efficiency, the Holding has the potential to bring its mandate into reality. Pusri Holding was formed on August 7, 1997, comprising PT. Pusri as holding and PT Pupuk Kaltim, PT Petrokimia Gresik, PT Kujang and PT Pupuk Iskandar Muda respectively as subsidiaries. The main goal of the holding among others are: to improve national productivity and efficiency as well as competitiveness and to gain the synergy effect in the future business development. However, the formation of Pusri holding raises questions on the ability to efficiently restructure and privatize the individual fertilizer centers 10. Overall, through the project, the Bank has made a positive contribution to the development of a technically efficient fertilizer industry comparable to world standards. Within the limitation of the Project's stated objectives, both the Bank's and the Borrower's performance in the various stages of the project cycle have been satisfactory. However, since a large part of the FSP is still to be implemented after project completion, project outcome is satisfactory only in terms of physical achievement and unsatisfactory in terms of solving the more fundamental policy issues of the fertilizer sector. From the project's point of view, sustainability of its accomplishments is uncertain, and from the country's perspective, Indonesia's plan to change its fertilizer industry into be a highly competitive and economically efficient remains an unfinished agenda. Summary of Findings, Future Operations, and Key Lessons Learned 11. Three important lessons can be drawn from the project, as follows: * Well-defined policy measures including quantitative targets and timetables should have been agreed with the Government in the design stage. Implementation of the fertilizer policy statement should have addressed more fundamental issues such as full sector deregulation, competition development, and privatization.. Coordination (or the lack of it), while being a classic issue, continues to be an important ingredient for policy implementation in a multiagency environment. In this context, a strong lead agency should have been agreed upon and appointed early in the design stage. * Strong technical capability, as shown by the PFCs, is of utmost importance in the implementation of an industry restructuring project that involves adding new production capacities and enhancing plant efficiency and productivity.

10 - viii Finally, it is important to note that project achievements and future operations of the PFCs are at risk if the current regulatory regime is maintained. This is even more so as optimized plants in PIM, Pusri and Kujang continue to age and will ultimately need replacement. Even under Holding management, short- and medium-term financial problems faced by the companies are not likely to be solved internally and external assistance, including private sector involvement, will have to be mobilized. This can be achieved in an efficient, competitive sector environment that is to be created through full sector deregulation, privatization of PFCs, and enhanced private sector participation.

11 - I - INDONESIA FERTILIZER RESTRUCTURING PROJECT (LOAN 3282-IND) PART I: PROJECT IMPLEMENTATION ASSESSMENT A. PROJECT OBJECTIVES AND DESCRIPTION 1. The primary impacts the project was seeking were an improvement in efficiency and performance of Indonesia's fertilizer industry, a reduction of budget subsidies, and minimization of adverse environmental impacts of fertilizer production. These impacts were to be achieved by accomplishing the following objectives: (a) to assist the Government in implementing an agreed Statement of Fertilizer Sector Policies (FSP) aiming at enhanced economic efficiency, improved distribution and marketing, and abating pollution; (b) to identify the scope for improved efficiency in marketing and distribution; (c) to assess the industry's environmental impact and standards, and prepare an environmental management program; and (d) to support an industry-wide investment program. The objectives were responsive to the need of the Indonesian fertilizer sector and no major modifications were made during project implementation. 2. Implementation of the FSP is the thrust of the project as it directly responded to the needs of the industry to restructure the gas input and product pricing system and to introduce competition in production and distribution so that overall industry efficiency could be achieved. This was to be accomplished by gradually bringing the prices of gas input and fertilizer products (both at factory and farm levels) to their respective economic prices, gradually eliminating budget subsidies and by reforming PT Pusri's distribution system. 3. To support FSP, two studies on fertilizer distribution and marketing and on development of environmental program management were commissioned by the Directorate General of Chemical Industry of the Ministry of Industry and Trade (MOIT). The studies came up with recommendations, some of which were implemented during project implementation. 4. To respond to a projected increase in demand for nitrogen fertilizer, the project supported an industry-wide investment program and provided funds for capacity investment in PT Petrokimia Gresik. This included (a) building a new ammonia/urea plant at Gresik, with a capacity of 1,350 tons per day (tpd) of ammonia and 1,400 tpd of urea, to provide low-cost ammonia to existing operations and to reduce urea distribution costs in East Java, including provision of engineering services and licenses therefor; and (b) supporting modernization investments in Gresik's existing fertilizer plants to increase

12 output of phosphoric acid and improve performance of the ammonium sulfate (AS) facilities and ameliorate environmental pollution. 5. Included in the industry-wide investment program was the optimization of ammonia/urea plants in PT Pupuk Iskandar Muda, PT Pusri, PT Pupuk Kujang, and PT Pupuk Kalimantan Timur. The objectives of the optimization were to improve efficiency of energy and raw material consumption, enhance output, and improve environmental performance of the plants. 6. The policies were spelled out in the Government's letter of November 10, These included plans to bring prices of gas input and fertilizer products (ex-factory and farm-gate levels) to their respective economic prices, to gradually eliminate budgetary subsidy, and to improve Pusri's distribution system. B. ACHIEVEMENT OF PROJECT OBJECTIVES Implementation of Fertilizer Sector Policies 7. Overall. Progress was observed during project implementation, including abolition of price controls over phosphate fertilizers, and gradual, albeit partial, adjustment of gas input and urea prices to reflect their economic prices. Fiscal subsidies have also been reduced by more than two-thirds. However, at the end of the project the sector remains dominated by the Government and its structure has not changed. Neither are the participating fertilizer companies (PFCs) in encouraging financial condition and able to sustain project achievements from their internal resources. 8. Pricing Policy. Ex-factory and farm-gate prices of urea continue to be adjusted. Compared to those at the project's inception year (1990) the ex-factory price has escalated by more than 170 percent and the farm-gate price by 190 percent. When the new farm-gate price (Rp 400/kg) 2 was announced in early 1997, with declining international prices and an exchange rate of Rp 2,200/US$1.00, the farmers were practically buying urea at higher-than-international prices. With the currency crisis beginning in June 1997 whereby the Rupiah lost more than 75 percent of its buying power against the dollar, fertilizer prices in Indonesia have become much lower than their international prices in dollar terms. 9. In 1993 and 1994 the Government abolished price controls on potash, phosphate, and AS. Subsequently PK Gresik discontinued production of triple superphosphate (TSP) and replaced it by SP36 (superphosphate with 36 percent of P ). As a result, production costs have been reduced and subsidies for TSP and AS totally eliminated over the past 2 In April the Government raised the farm-gate price to Rp 450/kg. still very low in dollars terms Nvhen the exchange rate was Rp 8,500 to a dollar. This price level is considered to remain affordable to the farmers as the Govenment has also raised the price of rice.

13 - 3 - two years. Although not totally eliminated, overall budget subsidies have decreased from Rp 457 billion in FY 1992/3 to RP 195 billion in FY 1996/ The Government has partially adjusted gas prices. Under current plans and with the expiration of old gas contracts (the original "Integrated Gas Purchasing Agreement" of 1975 covered a period of 20 years), gas prices are being increased individually plantby-plant. The following gas price adjustment have been reported: US$1.85/mmbtu for Pusri's plant numbers II, III and IV, US$1.50 for Pusri plant number I-B, for export US$1.85; PK Gresik US$2.00, for which US$1.00 will be reimbursed for domestic sales; and a special price formula (around US$1.60 to US$2.60) to be negotiated for new projects. According to the Ministry of Industry and Trade (MOIT), deregulation of gas price should be implemented around the year The limited adjustment of gas prices is inadequate to guarantee a stable gas supply from Pertamina. This is due to the growing number of competing gas users, private as well as public, who are willing to pay more than US$1/mmbtu. Kujang, Pusri, and PIM have in many instances experienced deteriorating gas supplies, which constrained production at maximum capacity. 12. Although not totally eliminated, overall budget subsidies have decreased from US$457 million during FY1992/93 to US$195 million in FY1996/97. These accomplishments notwithstanding, the adjustments continue to be government administered and tend to be less responsive to market trends. At the end of project implementation the sector remains heavily regulated with its inherent structural inefficiencies. 13. Marketing and Distribution. Despite clear evidence that substantial benefits may be obtained by restructuring the marketing and distribution system, the Government has been reluctant to introduce major changes in view of its desire to keep uniform fertilizer prices throughout the country and to ensure reliable delivery. This has led to excessive use of fertilizer products by farmers. There are indications that in certain parts of Indonesia, particularly in Java, agricultural output would not drop even if fertilizer application rates were reduced by 20 to 30 percent. However, most farmers are reluctant to reduce application rates out of a perception that less fertilizer may lead to less crop. In the meantime, the Ministry of Agriculture's (MOA's) annual fertilizer demand projection, which determines the volume of production, continues to use a more or less linear projection model and only recently has started, on a pilot basis, to work on revised demand projections based on systematic individual soil analyses. 14. Development of intrasectoral competition, full sector deregulation, and privatization were not articulated as formal policy options during FSP implementation. This led to a situation where efficiency enhancement measures affected only the public 3 See footnote 1.

14 -4 - sector producers and its scope was confined to technical rather than overall economic efficiency with limited repercussion in the private sector. 15. In September 1997 the Government established a Holding company by fully transferring its shareholding in each PFC to PT Pusri. The Holding, whose structure is still emerging, will coordinate and consolidate marketing and plant operations with a target of overall efficiency improvement in the fertilizer sector and subsequent pooling of domestic and international financial resources for future investments with private sector participation. The ultimate goal is to achieve full sector deregulation in the early 2000s and privatization of the PFCs. Environmental Management Program 16. In cooperation with BAPEDAL, MOIT has finalized and accepted waste water emission standards in the fertilizer sector that are based predominantly on EC standards. Work on air pollution standards is progressing and should be completed. An appropriate monitoring and enforcement plan has been prepared and three PFCs (Kujang, Pusri, and PIM) are participating in the scheme and achieved the "blue" rating (i.e., in compliance) in Kujang has been constantly in the "blue" since June 1995, when the first ratings were given. Pusri has been "blue" since December 1995, and PIM achieved the "blue" status in October For air quality, the program is just beginning as the standards will not be enacted until late Emissions monitoring, however has begun in conjunction with ISO now adopted by the PFCs. Industry-wide Investment Program 18. Overall. Indonesia has constructed and operated state-of-the-art fertilizer plants and many of these are among best-run plants in the world. This strong background facilitated satisfactory implementation of the industry-wide investment program. However, with declining international prices and an assumed US$2/mmbtu gas price, the five PFCs recorded lower-than-appraised rates of return. Consecutively, the Gresik rate of return is calculated at 7 percent (Staff Appraisal Report-SAR-15 percent), Kujang 8 percent (SAR 16 percent), Pusri 22 percent (SAR 32 percent), Kaltim 14 percent (SAR 32 percent), and PIM 10 percent (SAR, NA). In spite of their optimized condition, plants in Pusri, Kujang, and PIM have further aged and wear and tear in the plants have continued. The project has helped to compensate lower plant availability due to aging by higher and more efficient capacity. 19. PT Petrokimia Gresik Restructuring. The new ammonia and urea plants have been placed in service since 1994 and modernization of PK Gresik's phosphoric acid and AS facilities has been completed and in operation since The new plants are now fully operational, adding 460,000 tons of urea to the country's annual production capacity. Project completion was delayed about six months, mainly by the late arrival of gas at the battery limit due to delay in completion of Pertamina's natural gas pipeline. This caused increased interest and supervision costs and loss of production.

15 While energy efficiency of the new plants is in line with original expectations, the urea plant has not operated to its full potential due to scale deposits from the ammonia plant, which was not resolved at the time of writing of the ICR. The total cost for this component was US$316.2 million (SAR estimate US$305.4 million), of which US$126.3 million was financed by the Bank. The actual project cost was 4 percent higher than estimated, mainly due to appreciation of the Japanese yen against the US dollar. With higher project costs and lower international prices, the new plants' economic rate of return has been calculated at just 7 percent (based on gas price of US$2/mmbtu), compared to an SAR estimate of 15 percent. 21. Modernization of Gresik's phosphate plants is also showing a positive result in significant reduction of air and water pollution level. The total cost for this component was US$13 million (SAR estimate US$15.8 million), of which US$8.7 million was financed by the Bank. 22. PT Pupuk Iskandar Muda. PT PIM revamped its ammonia plant to increase production capacity from 1,050 tpd to 1,210 tpd (15 percent) and reduced energy consumption per ton of ammonia produced by 8 percent (3.3 mmbtu). PIM also installed a dust emission control equipment which could reduce urea dust emission to less than 50 mg/100 Nm 3. Total cost for PIM was US$17.8 million (SAR estimate US$15.2 million), of which the Bank financed US$10.7 million. Appreciation of the Japanese yen against the US dollar, price increases, and additional materials due to engineering revision contributed to the higher project cost. PIM financed the cost overrun from its equity. 23. PT Pusri. Pusri revamped its Pusri II plant to increase capacity by 150 percent to 1,725 tpd and energy use by 30 percent. The revamp was completed in 1994 and cost less than the final budget estimate. Pusri also added two urea hydrolizers to remove urea from its process condensate effluent, and a biological sewage treatment unit. This environmental project also cost less than budgeted. 24. The total cost for the revamp was US$33 million (SAR estimate US$36.1 million), of which US$22.1 million was financed by the Bank. The cost saving was accrued from a reduced scope in ammonia plant optimization. In addition, the total cost of the effluent treatment project was US$12.4 million (SAR estimate US$4 million) with Bank financing in the amount of US$2.8 million. The higher cost was due to the expanded scope of the environmental program. 25. PT Pupuk Kujang. Kujang revamped its ammonia plant to increase capacity and save energy. The revamp increased the ammonia plant's capacity daily production to 120 percent as planned, and saved about 2.65 mmbtu of gas per ton of ammonia produced. The total cost of this component was US$18.7 million (SAR estimate US$17.4 million), of which the Bank financed US$12.7 million. 26. PT Pupuk Kalimantan Timur. Kaltim modified its Kaltim I ammonia plant to increase capacity and save energy, and the urea plant to increase its capacity and reduce pollution. The ammonia plant capacity increased from 1,450 tpd to 1,800 tpd, adding

16 - 6 - more than 100,000 tpy, and urea from 1,700 tpd to 2,200 tpd. Kaltim I plant is now operating fully, indicating better plant availability and reliability than it was before the project when it operated at 10 to 20 percent below its capacity. Under the project, extra urea capacity also increased by 10 percent. The total cost of this component was US$44.2 million (SAR estimate US$41.4 million), of which US$31.7 was financed by the Bank. C. IMPLEMENTATION RECORD AND MAJOR FACTORS AFFECTING THE PROJECT 27. Lack of Leadership in Policy Implementation. Except for international prices of fertilizer, basically all factors important to the success of project implementation are within the influence of the Government and the PFCs. This is shown by the smooth implementation of the industry-wide investment program. In policy implementation, however, no specific institution showed a strong commitment and provided an effective leadership despite the fact that implementation of FSP required full commitment and cooperation from the Ministry of Finance, MOA, MOIT, and Ekku Wasbang in a coordinated fashion. 28. The Government commitment to guarantee availability of fertilizer products at affordable, uniform prices proved to be a constraint to introduction of competition into the fertilizer industry. This commitment requires a complicated and highly administered input/output pricing system and is dependent upon a monopolistic distribution systems. While the Government's continued strong concern about the plight of the farmer is well justified, the policy choice resulted in distribution inefficiency and excessive fertilizer use. 29. Appreciation of the Japanese yen against the US dollar contributed to higher project costs in Gresik and PIM. Also, declining international prices are a factor contributing to unfavorable PFC financial results including lower rates of return at the end of project implementation. D. PROJECT SUSTAINABILITY 30. The increase of gas input prices and the decline of export prices would adversely affect the PFCs' financial performance and would reduce the amount of internally generated funds available to finance future capacity investments. At the same time, Government guarantees are unlikely to be available for new external financing as the Government has decided to withdraw from financing such productive activities. Under these circumstances, even with establishment of the Holding company, PFCs' ability to sustain project achievements by relying on internally generated resources appears unlikely. In this case, external resources will have to be mobilized and appropriate incentives should be introduced to induce private investments. 31. Unless further sector deregulation and privatization are launched, sustainability of project achievements and of the PFCs themselves is in doubt. The Holding company, although not necessarily an ideal solution, should help to enhance sustainability if it has in its agenda a strong orientation toward policy reform. Moreover, it should be furnished with dedicated professional staff and must be fully supported by the Government.

17 - 7 - E. BANK PERFORMANCE 32. In 1988, the Bank commissioned a fertilizer sector study that came up with a recommendation that future investments in the sector should be to make fertilizer production competitive by international standards and improve the efficiency of the distribution system. To this end, the study further recommended that the Government develop a sectorwide investment program and launch sector policy reform with respect to input as well as output pricing. The study led to identification of this project. 33. In the identification stage, the Bank's strategy was to ensure that fertilizer sector policy reforms would be implemented consistently and in a timely manner to support the development of the sector. In project preparation, the Bank reviewed the adequacy of project design from its technical, financial, economic, commercial, and institutional as well as environmental aspects. However, greater attention could have been given to the project design, particularly in the formulation of sector policies for reforms. 34. During appraisal, a commitment were obtained from the Government to implement an agreed upon statement of fertilizer sector policy, which was signed by the State Minister of National Development Planning. The policy statement, however, was vague and not broad enough. The Bank appraised the capacity of the PFCs as implementing agencies of the investment component. However, the Bank was not successful in identifying and agreeing with the Government the suitable agency to be responsible for FSP implementation. This resulted in ambiguous policy implementation as there was no commitment from the Governrnent with regard to performance targets and an implementation timetable. 35. Nine supervision missions were fielded during implementation. The missions continuously proposed full deregulation of the sector and privatization of PFCs and suggested a policy implementation timetable. Problems identified and solutions proposed as well as performance ratings given were well-documented in the Form 590s. 36. Although the project did not realize its fullest potential, within the limitation of the stated objectives, the Bank generally performed satisfactorily. However, the project would have benefitted by better Bank performance during the design-phase of project preparation. The loan amount, together with counterpart and cofinancier funds, was sufficient to cover the investment needs and about 3 percent of the amount was canceled at the end of implementation period. F. BORROWER PERFORMANCE 37. The PFCs independently prepared proposals that led to preparation of the investment component of this project. Plant optimization proposals were finalized after the loan was declared effective. The proposals met technical as well as financial feasibility and were acceptable according to Bank standards. 38. The Government's and PFCs' commitments were best displayed by successful completion of the investment program. This reflects excellent project management

18 -8 - including right selection of consultants and contractors, timely availability of funds from PFCs' equities and cofinanciers and consistent progress monitoring. 39. On the policy side, the Government, as mentioned elsewhere, has been reluctant to take more comprehensive policy actions to enhance overall efficiency of the sector. Despite important achievement in reducing fiscal subsidies, the high-cost marketing and distribution system remains relatively intact. 40. Similar to the Bank's, judged from the project achieving its stated objectives, the Borrower's performance has been satisfactory. G. ASSESSMENT OF OUTCOME 41. The project has accomplished its stated objectives. However, viewed from the fact that it has missed the opportunity to address more fundamental sector issues, the accomplishments have been limited and overall sector efficiency objectives have not been achieved. Therefore, the outcome of the project is unsatisfactory. 42. Although all PFCs have implemented their investment program successfully, their financial performance has only partially met expectations. In addition to being caused by declining export prices, the lower-than-appraised financial results reflect the impact of current pricing policies. H. FUTURE OPERATIONS 43. To anticipate future demand for urea fertilizer, aging and deteriorating plants in PIM, Pusri, and Kujang have to be replaced and external financing needs to be mobilized. To this effect, the Government has to be more committed to full deregulation of the sector and to privatization of the PFCs so that private investments in the sector can be induced and fiscal burden from subsidies eliminated completely. Under the current economic situation this commitment is even more important and needs to be implemented with some urgency. 44. Support need to be extended to MOA, which is in the process of refining its fertilizer demand projection methods that will use systematic individual soil analyses more extensively. I. KEY LESSONS LEARNED 45. Well-defined policy measures including quantitative targets and timetables should have been agreed with the Government in the design stage. Implementation of the fertilizer policy statement should have addressed more fundamental issues such as full sector deregulation, competition development, and privatization. 46. Coordination (or the lack of it), while being a classic issue, continues to be an important ingredient for policy implementation in a multiagency environment. In this context a strong lead agency should have been agreed upon and appointed early in the design stage.

19 9-47. Strong technical capability, as shown by the PFCs, is of utmost importance in implementation of an industry restructuring project that involves adding new production capacities and enhancing plant efficiency and productivity.

20 - 10- PART II: STATISTICAL TABLES TABLE 1: SUMMARY OF ASSESSMENTS A. Achievement of Objectives Substantial Partial Negligible Not Applicable Macroeconomic policies Sector policies Financial objectives Institutional development Physical objectives Poverty reduction Gender issues Other social objectives Environmental objectives Public sector management Private sector development X X X X X X X X X X X B. Project Sustainability Likely Unlikely Uncertain x C. Bank Performance Highly Satisfactory Satisfactory Deficient Identification Preparation assistance Appraisal Supervision X X X X D. Borrower Performance Highly Satisfactory Satisfactory Deficient Preparation Implementation Covenant compliance Operation (if applicable) X X X E. Assessment of Outcome Highly Satisfactory Unsatisfactory Highly Satisfactory Unsatisfactory x

21 TABLE 2: RELATED BANK LOANS/CREDITS Year of Loan/Credit Title Purpose Approval Status Preceding Operations 1. Industrial Energy Establish institutional framework and policies for 1987 Completed Conservation planning. promoting. implementing and monitoring energy conservation activities. Following Operations None In parallel. demonstrate the benefits of energy conservation activities in industry through implementation of specific energy-efficiencv investments in PT Pusri. TABLE 3: PROJECT TIMETABLE Steps in project cycle Date planned Date actual/latest estimate Identification (concept review) NA February 21, 1990 Preappraisal (executive project summary NA February 1990 Appraisal March 5, 1990 May 1990 Negotiations NA October 29, 1990 Letter of development NA December 10, 1990 Board presentation August 7, 1990 December 20, 1990 Signing NA January Effectiveness NA NA Project completion NA NA Loan closing December 31,1997 December 31,1997 TABLE 4: LOAN/CREDIT DISBURSEMENT: CUMULATIVE ESTIMATED AND ACTUAL (US$ million) FY91 FY92 FY93 FY94 FY95 FY96 FY97 Appraisal estimate Actual Actual as% of adjusted estimate Date of final disbursement October 22, 1997

22 - 12- TABLE 5: KEY INDICATORS FOR PROJECT IMPLEMENTATION Key implementation indicators in SAR/ President's Estimated Actual Report (End of Project Target) (June 1995) 1. Loan Effectiveness May 1991 March Policy Measures (a) Annual Consultations Not later than October and Regularly performed from early thereafter 1992 and thereafter 3. Gresik Restructuring (a) Annual Consultations - Start construction October October 4, Construction and commissioning completed January 1994 June 1994 (b) Plant Modernization - Feasibility Studies and ElAs Not later than June 30, 1992 April 1992 (c) Preparation of EMP not later than November 30, 1991 September Optimization Subproject - Feasibility Studies and EIA Not later than June 30, 1992 August Studies (a) Marketing and Distribution - Setting up steering Committee Not later than May 1, Start June 1, Completion March 1, 1992 December Agreement on follow-up actions by GOI May 1, 1992 January 26, 1993 (review with Bank) (b) Development of EMP for the Fertilizer sector - Setting up Steering committee Not later than May 1, Start June 1, Completion March 1, Agreement on follow-up actions by GOI May 1, 1992 January 26, 1993 (review with Bank) TABLE 6: KEY INDICATORS FOR PROJECT OPERATIONS Not Applicable

23 TABLE 7: STUDIES INCLUDED IN PROJECT. Study Purpose as defined at Status Impact of Study Appraisal/Redefined 1. Indonesia Fertilizer Mar- Evaluation of fertilizer and rice Completed Input to implementation of FSP keting Study policy with particular reference to fertilizer distribution and marketing 2. Development of an Assess Indonesia's environmental Completed Establishment of environmental environmental management standards for the industry and standards for the fertilizer industry program for the fertilizer recommend changes and of an environmental manageindustry ment program for fertilizer producers TABLE 8A: PROJECT COSTS (US$ million) Appraisal estimate Actual/latest estimate Item Local Foreign Total Local Foreign Total Restructuring of PT Petrokimia Gresik Modernization of Phosphate/As plants Optimization of Pusri 11 Urea Plant Pusri Effluent Treatment Facilities Kaltim I Ammonia/Urea Plant Optimization of Kujang Ammonia Plant Optimization of PIM Ammonia Plant Studies Total Project Costs TABLE 8B: PROJECT FINANCING (US$ million) Appraisal estimate Actual/late estimate Source Local Foreign Total Local Foreign Total Equity IBRD/IDA Cofinancing (BNI) Japanese Grant Total

24 - 14- TABLE 9: ECONOMIC COSTS AND BENEFITS The five participating fertilizer companies recorded lower rates of return than appraisal estimates. Consecutively, Gresik 7 percent (SAR 15 percent), Kujang 8 percent (SAR 16 percent), Pusri 22 percent (SAR 32 percent), Kaltim 14 percent (SAR 32 percent), and PIM 10 percent (SAR, NA) TABLE 10: STATUS OF LEGAL COVENANTS Cove- Original Revised Agree- nant Present fulfillment fulfillment ment Section type Status date date Description of covenant Comments Loan 3.01 (b) (c) 3 C 01/16/91 NA Subsidiary loan agreement with Gresik for restructuring and modernization project (d) (e) (f) 3 C 01/16/91 Subsidiary loan agreement with PIM. (g) Kaltim. Kujang & Pusri. Project 4.01 (a) (b) I C Annually NA PFCs to maintain project financial fulfilled records and submit audit reports. Gresik C 11/30/91 09/9191 Gresik to implement an environmental management plan not later than November C 06/92 04/92 Gresik to submit to the Bank appraisal report and EIA for its modernization subproject (a) (b) I C Annually NA Gresik to maintain project financial fulfilled records and submit audit reports. Covenant Class: Status: I= Accounts/audits 8 = Indigenous people C = covenant complied with 2 = Financial performance/revenue 9 = Monitoring, review. and reporting CD = complied with after delay generation from beneficiaries 10 = Project implementation not CP = complied with partially 3 = Flow and utilization of project covered by categories 1-9 funds 11 = Sectoral or cross-sectoral 4 = Counterpart funding budgetary or other resources 5 = Management aspects of the allocation project or executing agency 12 = Sectoral or cross-sectoral policy/ 6 = Environmental covenants regulatory/institutional action 7 = Involuntary resettlement 13 = Other

25 - 15- TABLE 11: COMPLIANCE WITH OPERATIONAL MANUAL STATEMENTS There was no significant lack of compliance with an applicable Bank Operational Manual Statement (OD or OP/BP) TABLE 12: BANK RESOURCES: STAFF INPUTS Planned Revised Stage of project cycle Weeks US$'000 Weeks US$'000 Preparation to appraisal NA NA Appraisal NA NA Negotiations through Board approval NA NA Supervision NA NA Completion NA NA Total NA NA NA: Not Available. Source: COSR20 as of 12/29/97.

26 TABLE 13: BANK RESOURCES: MISSIONS Performance rating Imple- Devel- Stage of Month/ No. of Days mentation opment Typeof project cycle year persons in field Specialized staff skills represented status /a objectives problems Through Appraisal Up to 10 Industrial Specialist, Economists. 05/90 Chemical Engineer, Environmentalist. Operations Officer Appraisal through Up to 4 Chemical Engineer, Economist. Board approval 12/90 Operations Officer Supervision 1 05/ Industrial Specialists, Consultant S S Chemical Engineer, Environmental Consultant Supervision 2 09/91 1 Senior Chemical Engineer S S Supervision 3 03/92 3 Principal Industrial Specialist, Senior U U Financial Analyst, Senior Country Officer Supervision 4 01/93 2 Senior Chemical Engineer, Principal U U Industrial Specialist Supervision5 12/93 3 Senior Chemical Engineer, Operations U U Assistant. Senior Operations Officer Supervision 6 07/94 3 Senior Industrial Specialist. Sector S S Representative, Senior Agricultural Economist Supervision 7 06/95 4 Industrial Specialist, 2 Financial S S Analysts, Sector Representative Supervision 8 09/96 4 Privatization/Finance Specialist. S U Fertilizer Specialist. Financial Analyst. Operations Officer Completion 10/97 3 Operations Officer. Financial Analyst. S Industrial Specialist /a S: Satisfactory; U: Unsatisfactory.

27 -17 - ANNEX A ANNEX A: ICR MISSION'S AIDE MEMOIRE 1. For the preparation of the Implementation Completion Report (ICR) under the Fertilizer Industry Restructuring Project (loan 3282-IND), a World Bank mission 4 led by Mr. Kunrat Wirasubrata conducted a field visit from October 20-31, During this period, the mission met with the Ministry of Industry and Trade (MOIT), Ministry of Agriculture (MOA), Ministry of Finance (MOF), Coordinating Ministry of Economy, Finance, and Development Supervision (EKKU WASBANG), PT Petrokimia Gresik (GRESIK), PT Pupuk Iskandar Muda (PIM), PT Pupuk Kalimantan Timur (KALTIM), PT Pupuk Kujang (KUJANG), PT Pupuk Sriwidjaja (PUSRI), and PT Asean Aceh Fertilizer (AAF) and visited the GRESIK plant in East Java and the KUJANG plant in West Java. A list of key people met by the mission is attached (Annex-1). 2. Due to unexpected external difficulties, the mission was unable to conduct a thorough review of project performance and sustainability. These difficulties related mainly to two-incidents, i.e. (i) the project sites outside of Java (i.e. PUSRI, PIM and KALTIM) could not be visited since air-traffic to Sumatra and Kalimantan was interrupted in the region due to poor visibility; and (ii) senior government officials in several key ministries were unavailable to meet with the mission as they had to attend to the current foreign exchange crisis; the latter also affected resource availability within RSI. Consequently the TOR for the mission could not be fully executed; a decision is pending on the need for a follow-up mission within the near future to augment the limited project data obtained and plant visits conducted so far. 3. This aide memoire summarizes the main topics of the discussions held and the mission's findings and recommendations. The views expressed in this aide memoire are, however, the mission's own, do not necessarily reflect those of the World Bank, and are subject to review by the World Bank management. 4. The mission gratefully acknowledges the very friendly, frank and cooperative atmosphere of the meetings with GOI and the participating fertilizer companies (PFCs). 4 The mission comprised Messrs. Kunral Wirasubrata (mission Leader. Sector Coordinator. EACIF), Mr. Kurt M. Constant (Sr. Industrial Specialist. IENIM), and Unggul Suprayitno (Financial Analyst, EACIF).

28 -18 - ANNEX A SUMMARY 5. The primary Project objectives were to: * assist GOI in implementing an agreed Statement of Fertilizer Sector Policies aiming at establishing an internationally competitive industry; * identify the scope of improved efficiency in marketing and distribution; * assess the industry's environmental impact and standards, and prepare an environment management program; and * support an industry-wide investment program. 6. At the outset of the meeting the bank team explained that the main purpose of the mission was to compare original primary project objectives with actual achievements and study the lessons learned during implementation. The mission also stressed that sustainability and future growth in the Indonesian fertilizer sector would closely depend on successful implementation of crucial sector reforms including policy adjustments and improvement of overall production and distribution efficiency in Indonesia. Appetite for private investment in local projects will reflect international competitiveness of the Indonesian fertilizer sector in terms of financial project performance and input/output pricing. 7. Furthermore. the mission explained to MOIT and the PFCs outline and format of their required contributions to the final Implementation Completion Report (ICR) that will be attached unedited for distribution. GOI and the PFCs agreed to provide their relevant inputs and the MOIT will consolidate the feedback on the individual project components and provide a summary on GOI's views and conclusions. 8. MOIT expressed its satisfaction with the project results and the cooperation with the Bank during all phases of the project cycle. While a number of reforms have already been implemented such as deregulation of potash, ammonium sulfate and phosphate fertilizers. full deregulation of gas and fertilizer prices at factory-gate is anticipated for the year Following its objective of phased sector deregulation, GOI abolished price controls on potash in 1993/94. and on phosphate (TSP/SP36) and ammonium sulfate (AS) in 1994/95. Subsequently GRESIK phased-out TSP production and replaced it by SP36 (super phosphate 36% P,0 5 ). As a result of these adjustments production cost have been reduced and heavy earlier production subsidies for TSP and AS totally eliminated over the past 2 years. 10. Despite significant increases of urea prices in 1996 (farm-gate by 26.9% and factory-gate by 41.6%), and 1997 (factory gate by 15%), urea prices have not reached international levels and are still regulated. As a reference, Annex 2 provides a summary

29 -19- ANNEX A of March 1997 retail prices in the region. However, the reform continues and subsidized sales (including tax exemptions) to plantations and estates (cash crops) are being phased out faster than supplies for food crops, particularly rice. Full deregulation of urea at factory-gate level is expected for So far, gas prices have only been partially adjusted. Under current plans and with the expiration of old gas contracts (the original "Integrated Gas Purchasing Agreement" of 1975 covered a period of 20 years), gas prices are being increased individually plant by plant. The following gas price adjustments have been reported: PUSRI - #11, III, IV $1.00/MMBtu, PUSRI IB $1.50, for export $1.85; GRESIK $2.00 (currently receives $1.00 reimbursements for domestic sales); special price formula (around $1.60 to $2.60) to be negotiated for new projects. According to MOIT, gas-price deregulation should be implemented around year Since 1993 when the IFDC Fertilizer Marketing and Distribution Study was jointly reviewed by the GOI and the Bank, many of the minor recommendations have been implemented. including the involvement of small-scale traders at KUD level. The GOI has continued to support PUSRI's marketing system and its complex task of distributing fertilizers within the Indonesian archipelago, and has recently approved formation of a holding company under PUSRI that consolidates the five participating fertilizer companies (PFCs). 13. The Holding was established under PUSRI in September 1997 and its organizational structure is still emerging. Its objectives are to coordinate and consolidate marketing and plant operations with a target of overall efficiency improvement in the fertilizer sector and subsequent pooling of domestic and international financial resources for future investments with private sector participation. One of the Holding's first decisions was to select KALTIM (Bontang, East Kalimantan) and PIM (Lhokseumawe, Aceh Privince in North Sumatra) as export centers for international urea shipments. While export quotas still set by GOI for 1997, future export planning will be transparent and done by the Holding. The ultimate goal is to achieve full sector deregulation in the early 2000s. GOI has transferred its shares in the fertilizer industry to the Holding, which will ultimately be fully responsible for the management of the industry and its ultimate privatization. Consequently, GOI will in future only deal with the Holding as the new official representative of the Indonesian fertilizer industry. 14. After the study on the Environment Management Program of the Fertilizer Industry, BAPEDAL and MOIT have prepared and implemented environmental guidelines and emission standards in 1995 for wastewater. Standards for gas and particulate emissions to the atmosphere will be available by end The new local environmental specifications reflect international emission standards in industrialized countries. All five PFCs are participating in the new environmental control scheme and have passed liquid discharge standards ("blue grading").

30 ANNEX A INVESTMENT PROGRAM 15. Implementation of the investment components was successfully completed. All tests and guarantee runs met specifications and the project components have been running smoothly and efficiently in general. 16. Some adjustments of original budgets were required. They typically resulted from (a) scope extensions; (b) streamlining and/or expediting of procurement activities and project implementation to maximize economic benefits; and (c) close linkages of project tie-ins with annual turnarounds and market developments. Any overruns that incurred were funded internally and there were no fund shortages. IBRD loan allocations to the individual enterprises remained unchanged; some disbursement category adjustments were required. 17. Flexibility built into the project during appraisal allowed the Bank to approve requests for scope and disbursement adjustments in most instances. 18. Although all PFCs have implemented their project components successfully, their financial performances have only partially met expectations. The disappointing financial project results reflect the impact of current pricing policies and prevailing lack of incentives for higher operational efficiencies among state-controlled enterprises. The situation has recently deteriorated as a result of the foreign exchange crisis and corrective action is urgently required. GOI and the PFCs expect improved sector performances in production and distribution through the new Holding. 19. Current price regulations hit the new high-efficiency plants (PUSRI IB and GRESIK) particularly hard. In spite of lowest energy consumption in the country and high level of international competitiveness, these plans cannot sustain their operations without losses due to local pricing policies. Debt service capability of the enterprises is seriously hampered and future projects may be in jeopardy. Again. GOI and the PFCs expect improved sector performances in production and distribution through the new Holding. 20. Three additional problems have emerged during the project completion review that covers the full project cycle from the late 1980s until * First, old plants have further aged and would not have been able to maintain their preproject performances that were used without any adjustments as base case for project analyses. It turned out that wear and tear in the plants has continued and affected performance. The project has helped compensating lower plant availability due to aging by higher and more efficient capacity, but has not always achieved the anticipated maximum levels over longer production periods. * Second, during project implementation the number of gas users and their capacities have increased causing growing downstream competition for gas. As most competing gas users typically pay more for the gas than the (older) fertilizer plants, sustainability

31 - 21- ANNEX A of gas supply to the project has deteriorated and may constrain production at maximum capacity. Hence. sustainability of gas supply has become a critical issue. Third, despite competent and experienced management, the PFCs are not always fully motivated to go for maximum profitability, as benefits are usually only marginal. The available bonus systems linked to physical budget performances may not always have their full effect. 21. GOI and the PFCs are aware of these problems and confident that the newly established Holding will soon be able to also resolve these issues through consolidation of resources and planning that aims at obtaining maximum synergy effects. REFORMS IN THE FERTILIZER SECTOR 22. After initial deregulation of potash phosphate (TSP/SP36) and ammonium sulfate (AS) deregulation followed in Furthermore and following Bank recommendations, the production of TSP as GRESIK was stoppped replaced by SP36; certain parts of Indonesia started applying ground phosphate rock, where suitable. This has resulted in significant reductions of production costs and total elimination of the heavy earlier production subsidies for TSP and AS At GRESIK (estimated 1993 subsidies were US$ 60 million for TSP and US$ 15 million for AS). 23. The Coordinating Ministry of Economy, Finance, and Development Supervision (EKKU WASBANG) reiterated that food security, particularly reliable supply of rice, is still one of the most important Govemment objectives. Hence, there have been substantial delays in full sector reform. particularly farm gate prices of urea. However, GOI is aware of the potential and need for improved efficiencies in agriculture, industry, and distribution and agrees that full subsidy removal should be the ultimate goal of the reform program. As a first (and probably temporary) consolidated initiative toward improved industrial fertilizer activities, GOI feels confident that the establishment of the new Holding will provide valuable contributions including introduction of least cost distribution and synergy in projects, operations. and marketing. 24. The mission feels that the Holding is probably not the ideal solution, but is likely to help achieving substantial improvements on the short to medium term. In order to facilitate its success it will need to be properly staffed and have access to highest quality local and international expertise, as its required role will be exceptionally demanding and important. Additionally, final and annual targets and objectives of the Holding should be quantified and integrated in its budgets as soon as possible. MOF. MOIT, EKKU WASBANG and the Holding agreed that the long term goal of the reform is sector deregulation and privatization of the fertilizer enterprises in a competitive environment. 25. The Ministry of Agriculture is working on revised fertilizer demand projections and there is increased interest in fertilizer recommendations based on systematic individual soil analyses. Unfortunately, availability of funds for the piloting appropriate soil sampling, analyses and fertilizer recommendations is very limited at this stage. The