ASIAN DEVELOPMENT BANK IES:INO 97010

Transcription

1 ASIAN DEVELOPMENT BANK IES:INO IMPACT EVALUATION STUDY OF BANK OPERATIONS IN THE INDUSTRIAL CROPS AND AGRO-INDUSTRY SECTOR IN INDONESIA August 1997

2 CURRENCY EQUIVALENTS Currency Unit - Rupiah (Rp) Rp1.00 = US$ US$1.00 = Rp2, ABBREVIATIONS DGE - Directorate General of Estates EIRR - Economic Internal Rate of Return FFB - Fresh Fruit Bunches GDP - Gross Domestic Product IES - Impact Evaluation Study IPM - Integrated Pest Management NES - Nucleus Estate and Smallholders PCR - Project Completion Report PMU - Project Management Unit PPAR - Project Performance Audit Report PTP - Perseroan Terbatas Perkebunan (Government-owned Corporation) SSTA - Small-scale Technical Assistance TA - Technical Assistance NOTES (i) (ii) The fiscal year (FY) of the Government ends on 31 December. In this Report, "$" refers to US dollars. IE - 43

3 EXECUTIVE SUMMARY The industrial crops comprise the tree crops subgroup namely oil palm, rubber, coffee, cocoa, tea, and cashew nut; and crops such as sugar, cotton, and other fiber crops. Together, the industrial crops occupy 40 percent of the cultivated land, account for more than 17 percent of the agricultural gross domestic product, provide employment for 30 percent of the labor force, and contribute to the country s non-oil foreign exchange earnings. As of June 1997, the Bank had approved 18 loans totaling $683 million for 17 projects, and 26 technical assistance (TA) operations amounting to $8.6 million for the agroindustry and industrial crops sector. Most of this has supported tree crops. The Bank s loans comprise about one third of the external assistance, and about 5 percent of the total investment for the tree crops subsector. Eleven of the Bank-assisted projects have been completed and five of these postevaluated. Of the five postevaluated projects, three were generally successful, and two partly successful. The Bank s assistance has followed the Government s development directions and strategies. Thus, the first five projects, implemented from 1970 to 1981, aimed primarily to expand and rehabilitate public sector plantations and processing facilities. The key goals for these earlier projects were increases in non-oil exports and public sector foreign exchange earnings. Although smallholders were involved in some of the earlier projects, it was not until after 1980 that smallholder development became a primary focus. All of the six completed projects initiated between 1981 and 1988 were directed wholly or partly towards improving smallholder incomes. Five of these projects were based on the nucleus estate and smallholders (NES) development model where smallholders are settled onto crop land established for them surrounding a central estate and processing facility. In addition to improving conditions for smallholders, improvements in food security, export diversification and foreign exchange earnings, and an improved regional balance of development were important goals at the time. Since 1989, the Government s development approach for foreign-assisted projects has focused on the use of the project management unit (PMU) approach whereby existing smallholders are assisted to improve production and processing through extension and credit support provided under the projects. All of this group of projects are ongoing. Seven of the eleven completed Bank-funded projects focused on oil palm and form a significant, relevant, and generally successful development effort. The projects were supported by Bank TA geared towards deregulation of the oil palm industry. Each project is meeting its area target, and the crop yields and factory productivity are satisfactory and sustainable. These projects are economically viable as indicated by their recomputed economic internal rates of return of 10 to 20 percent. Although their institutional impact is modest, the projects are having a positive impact on farm incomes and poverty reduction, foreign exchange earnings, food self-sufficiency, and economic growth. Their negative impact on the physical environment is minor. The success of the projects, coupled with the industry deregulation as a

4 iii result of the Bank TA, have stimulated additional private investment in parts of Sumatra, where the Bank-funded oil-palm projects are concentrated. The success achieved with oil palm has been largely due to the crop s competitive advantages. The yields have been consistently good and the prices for palm oil, expressed in local currency, have been consistently attractive. However, the scale of the combined projects for oil palm, their concentration in specific locations and with the same implementing agency, the sequential approach to development which built upon strengths established under earlier projects and the complementary TAs, constitute a sound long-term development program. Important criticisms of the program, however, are the high public cost per beneficiary of the NES approach and the focus on new land development as opposed to the improvement of existing farmland. The successes with oil palm were not repeated in the two completed Bank projects involving cotton and cocoa/coconut that experienced underachievement of the projected area and yield targets, and negative economic internal rates of return. The cocoa crop also has been infested with pod borer which affects sustainability of the small gains already achieved. Both these projects were developed using the NES approach, but the conditions for success inherent in the oil palm projects were lacking. Overall, neither the smallholders nor the nucleus estate developers have benefited greatly from the cocoa/coconut and cotton projects. Moreover, investments in these projects appeared ad-hoc in nature, not forming part of any long-term development program for either the areas or crops involved. The two other completed Bank projects within the sector involved sugar and fiber crops but were not reviewed under this study. The Bank s ongoing projects in the tree crops subsector have attempted to spread development over as wide an area as possible by adopting the PMU approach which has a low cost per beneficiary compared with the earlier NES schemes. The initial experience from these ongoing projects suggests that the expected output targets may not be fully achieved as smallholders do not use high input, high output production systems. Further, the prevailing market system does not encourage efforts to improve product quality. Consequently, some of the appraisal assumptions regarding beneficiary participation, the effectiveness of extension services to cause change in production systems, and projected yields appear overoptimistic at this stage. In addition, the main crops supported under the PMU projects are rubber, cashew, and tea that have lower potential than oil palm for raising farm incomes. The replanting program where trees of low productivity are replaced by higher yielding varieties is expected to give the best results. However, there are indications of variable quality in tree establishment and maintenance. There also are doubts that the developments will be adequately supported at the end of the project implementation period. After project completion, the provincial staff must take over the smallholder support functions using their regular budget which is less than that provided to the PMUs.

5 iv The Bank s experience within the sector to date highlights the value of selecting projects that form part of a long-term plan for an area, crop, or community. Advisory and operational TA can provide important support for such long-term development programs. Where long-term planning is weak, the requirement under the Bank s loans to finance all related aspects within a 5-6 year time frame can contribute to the setting of overambitious development targets. Although the NES approach to development entails high cost, the abrupt and complete change from NES to PMU approach which occurred in the late 1980s needs to be carefully reexamined because the NES approach has proven to be successful for oil palm. Rather than being totally rejected, the NES development approach should be further refined, such as by using it only where conditions are favorable, and limiting the area developed per beneficiary under a project so as to reduce the per beneficiary cost. More private sector participation in establishing NES projects, could also be encouraged. Since the PMU approach also appears to be producing mixed results, its review and improvement are also appropriate. The experience to date shows that a successful outcome under the NES approach requires (i) strong profitability of the core productive unit or crop; (ii) adequate capacity and capability of the nucleus estate and/or mill operator to implement and operate the scheme; and (iii) a strong interdependence, for example, through product processing, between the nucleus estate (and/or mill operator) and the smallholders to facilitate credit recovery. The sector experience also indicates that smallholders do not generally adopt high input, high output production systems. Even in the NES oil palm projects which provide a relatively assured and high income, the smallholder producers use lower than recommended amounts of fertilizer and adopt relatively low management standards. Future project preparation and appraisal studies should address this issue in the design of specific components and/or should use conservative assumptions about farmer responses and the yields that are to be expected. This will help avoid problems arising from smallholders viability to repay the loans under credit packages. In addition to the use of conservative yield assumptions during appraisal, appropriate risk analysis is needed. There also do not appear to be any significant and widespread price incentives for higher quality for industrial crops such as cocoa and rubber. Given this situation, efforts to improve smallholder incomes through improvements in the quality of crop outputs will be difficult. The experience also suggests that project performance targets need to be defined in terms of the development objectives, rather than simply in terms of physical achievements. Achievement of the latter may not necessarily lead to the project objectives. The preparation of a project framework during project identification and subsequent refinement during project preparation and appraisal would help in this regard. The application of this tool should enable flexible and speedy responses to changes during project implementation, while ensuring that project inputs and outputs remain consistent with goals and beneficiary absorptive capacities.

6 v The review of the Bank s assistance has indicated areas where the Bank may improve its support to the sector, including strengthening the Government s medium to longterm planning capability and overcoming weaknesses in the NES and PMU approaches. The review has also identified scope for improving the completed oil palm projects, including the need to address the balance between crop production and processing capacity, correction of management deficiencies in the mills, and improvement of fertilizer use. The spread of the debilitating cocoa pod borer to one of the project areas also raises concerns about the need to strengthen interprovince quarantine which may be addressed under the Bank s ongoing Integrated Pest Management for Smallholder Crops Project (Loan No INO). However, effective quarantine may only be practical for some of the more isolated provinces, e.g., Irian Jaya.

7 I. INTRODUCTION 1. The industrial crops, and the agro-industries concerned with the processing of these crops, are an important part of Indonesian agriculture. Oil palm, rubber, coconut; the beverage crops of coffee, cocoa, and tea; sugar, cotton, and other fiber crops, such as kenaf; and cashew nut are the main industrial crops. Together, they occupy 40 percent of the cultivated land, account for more than 17 percent of the agricultural gross domestic product, and provide employment for 30 percent of the labor force. Rubber, oil palm, coconut, coffee, and cocoa contribute about half of all agricultural exports, equivalent to about 18 percent of all nonoil exports. Understandably, in its various development plans, the Government has given importance to industrial crops. 2. The Bank s first involvement in the industrial crops and agro-industry sector in Indonesia was in As of June 1997, the Bank had approved 18 loans totaling $683 million for 17 projects, and 26 technical assistance (TA) operations amounting to $8.6 million (see Appendix 1).1 Eleven of the Bank-assisted projects have been completed and five of these postevaluated.2 Of the five postevaluated projects, three were generally successful and two, partly successful. 3. This Impact Evaluation Study (IES) aims to assess the broad impact of the Bank s operations on the sector s performance, draw out common lessons from the experience, and provide recommendations that may help improve future operations. The impacts of most concern are those on the socioeconomic conditions of smallholder beneficiaries, the financial and institutional capability of the entities involved in the projects, the national economy, and the environment. 4. The main changes and impacts brought about by projects become evident only after completion of project implementation and the harvesting of the crops has started. Hence, the study material has been drawn predominantly from the Bank s 11 completed projects. These 11 projects do not cover all aspects of the industrial crops and agro-industry sector, but have been primarily concerned with oil palm and the nucleus estate and smallholders (NES)3 development approach. Consequently, the IES focuses mainly on these aspects of the sector. In addition, for purposes of providing broad benchmark information and a framework for assessment, the study has limited its attention to the tree crops subsector. The tree crops subsector is a commonly adopted grouping for which broad data is available, and it includes oil palm, rubber, coconut, and cocoa for which the Bank has provided most support under its completed and ongoing projects. 1 A number of general agricultural projects, for example, area development projects, have also provided some support for the industrial crops, but are not included in this group. 2 One of these five postevaluated projects was reevaluated in August 1989 (IE-10:A Reevaluation Study of the Gohor Lama Palm Oil Processing Project in Indonesia). 3 The NES approach is described in para. 10.

8 iii 5. The reviews of individual projects for this IES were conducted under a Smallscale Technical Assistance (SSTA)4 implemented during September to October 1996 (see Appendix 2). The SSTA reviewed a small number of similar projects funded by the World Bank and the private sector for purposes of comparison. The results of the SSTA were supplemented by an Impact Evaluation Mission to Indonesia in October 1996 which discussed sector performance with staff of the Government agencies, the public estate companies and private sector entities involved in the sector, and which made field visits to Bank-funded Project sites. Information was also obtained from postevaluation and Project Completion Reports of the Bank and the World Bank, and previous Bank TA reports, notably, the Study on Monitoring the Impact of Policy Changes and Investments on the Tree Crop Sector.5 Where possible, the IES is also based on reviews and preliminary results of the ongoing Bank-assisted projects. II. BACKGROUND A. General Features of the Tree Crops Subsector 6. In 1995, the main tree crops, ranked in terms of crop area, were coconut, rubber, oil palm, coffee, cocoa, cashew, and tea. Their combined area was 11.6 million hectares (ha) (see Appendix 3).6 The situation was quite different in the late 1960s when the Bank first became involved in the sector. At that time, the total tree crop area was only 4.6 million ha and dominated by rubber and coconut. The areas of oil palm, coffee, and tea were small, and cashew was an insignificant crop. For the period from 1970 to 1995, there was a steady growth of 3.6 percent per annum in the tree crop area combined with a rapid rise in the importance of oil palm, and, to a lesser extent, cocoa and cashew. These trends are expected to continue over the foreseeable future. 7. While the major tree crops are grown throughout Indonesia, there is a pronounced concentration in western Indonesia.7 Most of the rubber area is on Sumatra and Java, and in the province of West Kalimantan. Oil palm is concentrated on Sumatra and in West Kalimantan, and tea, on Java. Eastern Indonesia accounts for less than 30 percent of the total area of the major tree crops. The dominance of western Indonesia comes from the area s climatic suitability for tree crops, the historical population distribution pattern, and the concentration of the early private estates in these areas. 4 TA No INO:Assessment of the Effectiveness of Bank Assistance to the Industrial Crops and Agro- Industry Sector ( ), for $100,000, approved on 18 June TA No INO for $450,000, approved on 31 December Sugar and cotton which have received one Bank-assisted project each occupied 405,000 ha and 34,000 ha, respectively. 7 The islands of Sumatra and Java, and the province of West Kalimantan.

9 iv 8. In the early 1970s, a little over 80 percent of the tree crop area was owned by smallholders. The other two producer types are the Government estate companies (referred to as Perseroan Terbatas Perkebunan or PTPs) and the private estates which each owned about 8 percent of the total area. Since then, and more particularly, since 1986, the private estate subsector has grown rapidly and accounted for 14 percent of the total tree crop area by In 1995, smallholders accounted for about 79 percent of the area, and the PTPs, 7 percent. Whereas coconut, rubber, coffee, cocoa, and cashew are predominantly smallholder crops, oil palm and tea are predominantly produced by the private estates and the PTPs. Despite the relatively rapid growth in the proportion of land owned by private estates, the major increase in tree crop area has been of that owned by smallholders. 9. Smallholdings are about 0.5 to 2.5 ha in size. Both food and tree crops are produced. Production typically uses low levels of inputs, and outputs are generally sold in their most basic and simple forms, such as lump rubber as opposed to smoked sheets or latex, dried cocoa beans as opposed to fermented beans. Except in the case of oil palm fruits which in most cases are sold to nucleus estate mills (see para. 10), the marketing of smallholder tree crop produce involves a network of village agents and several levels of private traders. While effective in collecting and channeling the myriad small quantities from the smallholders, this system does not normally provide incentives for producing higher quality outputs. 10. A growing group of smallholders are those in NES schemes. Typically in these schemes, undeveloped areas are brought under cultivation and smallholders from nearby areas or transmigrants from other provinces are settled in the area and provided with land, houses, and community facilities. In the case of schemes with tree crops, smallholders are normally allocated two to three ha including one to two ha of tree crop that was planted for them under the projects. A nucleus estate which normally also has facilities for the processing and marketing of both smallholder and nucleus estate production is established adjacent to the smallholder area. Most of the early established NES schemes are operated by the PTPs, but from 1985 private entities have been encouraged to also participate in this type of scheme. The ratio between the crop areas for the smallholders and the nucleus estate was initially 60:40, but changed to 80:20 in the mid-1980s. 11. The PTPs are Government-owned corporations which evolved out of the estate companies formed to take over the Dutch estates nationalized in the late 1950s and other Government estates. Since the time of their formation, many changes have occurred in their structure and form.8 They produce a range of tree crops, other industrial crops such as sugar and fibers, and livestock. Although the PTPs are autonomous and, financially, are to operate independently of the Government budget, they are Government corporations and retain some social functions. Large numbers of staff and regulations on their operations also constrain the extent to which they may act in true commercial fashion. Beginning in 1977, the PTPs were 8 Currently, i.e., in , they are undergoing a further change to become 14 separate Perseroan Terbatas Perkebunan Negara (PTPN), organized according to geographic coverage. In this Report, the earlier PTP structure is described and analyzed since the available data is organized according to the older PTP structure and has not yet been reorganized by PTPN.

10 v used as development agents for smallholders through their involvement as NES scheme operators. 12. Although there are a large number of private estates, 60 percent have land areas of less than 1,000 ha. Only 33 companies have areas of over 10,000 ha and of these, six companies stand out as being large, diversified conglomerates with over 100,000 ha of tree crops each. About 100,000 ha are controlled by foreign companies. The land of the private estates is held under leases of 35 years, extendible for a further 25 years. While the larger private estates appear to achieve yields and efficiencies that can match or exceed those of Malaysian companies, the smaller estates typically suffer from inadequate management and investment in infrastructure, and, as a result, often achieve poor financial results. B. Government Development Objectives and Support 13. In the 1970s, economic growth was a major development goal. To achieve the growth objective, an increase in foreign exchange earnings, particularly in the public sector was viewed as important. This meant that the public sector was to assume a direct role in productive activity, and developments which enabled import substitution or increased foreign exchange earnings were favored. Later, with the collapse of the mineral oil prices following the oil crises of the 1970s, diversification of the country s export base increased in importance. Self-sufficiency in food, including cooking oil, poverty reduction and a more balanced regional spread of development were added as explicit national goals in the early 1980s. In more recent years, environmental protection and sustainable development have gained in importance. Currently, the important goals are sustainable economic development coupled with export diversification, poverty reduction, a better regional balance in development and protection of the environment. Food self-sufficiency and public sector expansion also still remain as goals. 14. Throughout the period from the 1970s onwards, the tree crops, as well as other industrial crops, and the PTPs which maintained estates of industrial crops were viewed as vehicles for achieving the national goals. Although smallholders were included in some early development efforts,9 it was only from the start of the 1980s that major efforts were made for development of smallholder tree crops. Active encouragement of the private sector10 started later, from the mid-1980s when special credit programs were introduced and the process of granting land use permits for tree crop estates was improved. 15. The Government provides general guidance and technical support for the tree crops subsector through the Directorate General of Estates (DGE). Following the devolution of many responsibilities to the provincial level, regular operations within the subsector at the smallholder level are undertaken by the provincial extension service for estate crops (Dinas 9 For example, the Bank-funded Fiber Production and Processing Project (Loan No. 189-INO), approved in 1974 had a smallholder component. 10 In this Report, the term private sector is meant to comprise private corporations, and excludes smallholders.

11 vi Perkebunan) in each province. It is significant, however, that the majority of the smallholder tree crop area does not receive assistance from Government, and that the large expansion in smallholder area was largely done by the smallholders themselves. The Dinas Perkebunan is constrained by limited resources, operational budget and staff capability. In addition to its general support, the Government has provided specific assistance to smallholders through projects which have been of two main types. The first type comprises the NES schemes which have been implemented by the PTPs. Under the second type of project, referred to as Project Management Unit (PMU) projects, existing smallholders are assisted with technology, credit and simple crop processing and marketing support channeled through a PMU organized by the DGE. The DGE has a special team (Tim Khusus), which provides assistance to the PMUs on procurement, budgeting, recruitment, start-up activities, and legal matters. Where the PTPs are the implementing agencies, the role of the DGE is mainly supervisory and advisory in nature. The Government s projects have supported about 11 percent of the smallholder tree crop producers, comprising about 5 percent under NES schemes and 6 percent under PMU projects. Direct special support for the private sector has been limited to subsidized credit, particularly for private NES projects. Termination of the subsidized credit in 1990 coincided with reduced interest by the private sector in private NES projects. C. Investment Within the Subsector 16. A total of $9.2 billion was estimated to have been invested in the tree crops subsector from 1969 to 1993 (see Appendix 4). About 59 percent of the investment was made by, or for, smallholders. A further 26 percent was for private sector estates, and the balance was for public estates. By crop, the largest investment was for oil palm ($2.9 billion), followed by coconut ($2.1 billion), and rubber ($2.1 billion). 17. Foreign assistance for the tree crops subsector totaled $1.53 billion or 17 percent of the total subsector investment. The World Bank has been the major contributor, having provided $909 million up to the end of The Bank provided $491 million, equivalent to 32 percent of the external assistance, and about 5 percent of the total investment within the subsector, over this same period. Other major sources of financial assistance have been the International Fund for Agricultural Development, Germany, the United Kingdom, and Saudi Arabia. D. Bank Assistance ( ) 18. The Bank s assistance has followed the Government s development directions and strategies (see Table 1 and Appendix 5). Thus, the first five projects, implemented from 1970 to 1981, aimed primarily to expand and rehabilitate public sector plantations and processing facilities. The key goals for these earlier projects were increases in non-oil exports and public sector foreign exchange earnings. Although smallholders were involved in some of the earlier projects, it was not until 1981 with Loan No. 499-INO:Palm Oil Processing and Smallholder Development that smallholder development became a primary focus. From 1981 to

12 vii 1988, the Bank financed six projects, all of which were directed wholly or partly towards improving smallholder incomes. Five of these projects were NES schemes. In addition to improving conditions for smallholders, improvements in food security, export diversification and foreign exchange earnings, and the regional balance of development were important goals in line with the overall Government objectives at the time (see para. 13). 19. Towards the end of the 1980s, the NES approach was replaced by the PMU approach in Bank-financed projects. The PMU approach focused entirely upon existing smallholders. Whereas the NES schemes were concerned with new area development, the PMU-based projects were designed to assist smallholders in existing farm areas. At this time also, in accordance with the Government s objectives, emphasis was given to environmental issues and the sustainability of development, such as by explicitly basing crop improvements on sustainable forms of agriculture, moving away from commodity-based projects to ones which were concerned with farming systems (e.g., upland farming) and introducing integrated pest management (IPM). Table 1: The Bank-assisted Projects Loan Implementation Main Beneficiaries Main Crops Implementation No. Period Method a to 1975 PTP Oil palm PTP to 1976 PTP Oil palm and rubber PTP to 1987 PTP and smallholders Sugar PTP to 1980 PTP and smallholders Kenaf, jute PTP to 1981 PTP Oil Palm PTP to 1987 PTP and smallholders Oil Palm NES to 1988 PTP and smallholders Cotton NES to 1991 Smallholders Tree crops DGE to 1992 PTP and smallholders Oil Palm NES to 1994 PTP and smallholders Oil Palm NES to 1995 PTP and smallholders Cocoa NES ongoing Smallholders Rubber and tea PMU ongoing Smallholders Upland crops PMU ongoing Smallholders Rubber and oil palm PMU ongoing Smallholders Tree crops PMU ongoing Smallholders Upland crops PMU ongoing Smallholders Tree crops DGE a PTP: implemented by the PTP using its normal management structure. NES: NES scheme implemented by PTP. DGE: implemented by DGE/other agencies using Project Management Offices. PMU: implemented by DGE using Project Management Units.

13 viii 20. The reasons why the Bank changed away from NES projects to the PMU- based projects are not clear. However, it parallels a similar change in the design of World Bankfinanced projects. One probable reason is the higher development cost per beneficiary of NES projects compared with PMU projects. The cost, in constant 1996 values, of the smallholder components of the NES projects has ranged from $7,127 to $21,614 per beneficiary (see Appendix 6). The NES cotton project was much lower, because of the absence of land development. In contrast, the cost per beneficiary of the PMU-type projects is much lower, ranging from $441 to $1,524 in 1996 values. While this cost data tends to favor the PMU approach, it must be tempered by income expectations which are higher for beneficiaries under the NES projects than those under the PMU projects. The NES projects provide one to three hectares of crop land per beneficiary and smaller allocations would have produced costs and incomes per beneficiary in line with those achieved under the PMU projects. 21. In the NES projects, less than 5 percent of the project cost was expended for institution building, such as staff training, consultants, and project management. This is because the PTPs which implemented the NES projects have had adequate expertise and experience, partly built up through successive Bank-assisted projects. In contrast, institution building in the PMU projects comprises 20 to 30 percent of the project cost. 22. The six Bank-supported oil palm based projects form a sequential development. The first projects built up expertise within PTP II. Under Loan No. 499-INO, PTP II was used to implement a pilot NES Project. Based on the initial successes of this pilot, a further two NES projects with oil palm and two NES projects based on other crops were commenced. The Tree Crop Smallholder Sector and Smallholder Tree Crop Processing Projects (Loan Nos INO and 1186-INO) approved in 1991 and 1992 form another combined effort to uplift smallholder production by attacking production and processing problems in the same general area. These will also be supported by the latest approved project which provides for IPM. In comparison, the other projects for cotton and cocoa/coconut appear as individual, one-off efforts to develop a particular area or group of smallholders, and do not appear to form part of an overall long-term development plan. 23. Of the Bank s TA program, 17 TAs have been for project preparation and 8 TAs were operational and advisory. All but two of the project preparatory TAs resulted in loan projects. Three of the operational and advisory TAs provided inputs into loan projects, while four generated sector information, and one provided information for this IES. E. External Factors 24. International prices, exchange rates, interest rates, and Government controls on land and trade are the main external factors affecting the sector. All of the outputs of the Bank s projects are internationally traded and have been affected by falling international prices. The fall in prices was significant over the period of the 1980s. Oil palm and coffee prices have improved

14 ix since 1990, but prices for the other supported tree crops, i.e., tea, rubber, and cocoa have remained low. During this time, inflation was relatively high which increased the cost of production, but the effect on profitability was compensated by depreciation of the exchange rate which, particularly for oil palm, kept output prices expressed in rupiah at attractive levels. 25. Throughout most of the 1970s and 1980s, the Government tightly controlled the trade of oil palm in all its various forms, copra and coconut oil, and coffee. The trade in other commodities has not been regulated. Palm and coconut oils are the main cooking oils in the local market and the effect of the controls was to channel a large part of output into the domestic market. This was in line with Government s objective of ensuring self-sufficiency in basic commodities. Domestic prices have generally been high relative to international prices. Nevertheless, the controls distorted the market. There are also a number of export taxes which distort the market. Many of the controls on coconut and palm oils have been relaxed, but the trade in these commodities, along with rubber products, continues to be monitored. 26. On the supply side, the development of estates has been controlled through the issuance of business permits and access to land. These have slowed down the rate of development of private estates. High domestic interest rates which help to channel domestic savings into financing the national current account deficit also restrict private sector development. III. IMPACT OF BANK ASSISTANCE A. Contributions to Production 1. Crop Production 27. The Bank s completed projects have utilized technology that was up to date and comparable with that used in similar non-bank funded developments. The impact on crop productivity has been mixed. It has been generally good for oil palm, rubber and sugar, but less satisfactory for cotton, cocoa, and coconut. However, in terms of the overall sector, a significant impact on production so far has been achieved only with oil palm. This is because oil palm is the only crop whose area and production have been significantly expanded under the completed Bank-financed projects. 28. For oil palm, the Bank assisted the rehabilitation of 6,400 ha and the new planting of 41,000 ha under six of the completed projects. Although this represents only around 2.5 percent of the oil palm area, it has been concentrated in three provinces, namely, North

15 x Sumatra, Riau, and Irian Jaya which enhances its visibility and impact. Smallholders associated with NES schemes own 65 percent of the assisted area, while the balance is owned by PTP II in the nucleus estates of NES schemes or as stand alone estates. Establishment and rehabilitation of the oil palm area were satisfactorily done. This was because all of the area, including that for smallholders, was established as large scale plantations, and was done by PTP II which had appropriate experience and expertise, largely built up through the implementation of successive Bank-funded projects. 29. Average peak yields of the Bank-assisted oil palm areas exceed 20 tons (t) per ha of fresh fruit bunches (FFB). These are double those prevailing before the Bank s initial involvement, but are about 10 to 15 percent less than those obtained by private estates, and about 10 to 25 percent less than projected at appraisal. The satisfactory yields are due, in part, to the incorporation in the projects of the high yielding varieties of oil palm, the introduction of pollinating insects, and improvements in fertilizer management. The smallholders normally use less fertilizer and obtain slightly lower yields than the nucleus estate. The establishment, operation, and yield of the Bank-assisted oil palm areas are similar to those of the areas developed under non-bank projects. Like those other areas, further improvements in fertilizer use are possible, including the use of fertilizers other than urea as the source of nitrogen. The low rates of fertilization by oil palm smallholders and the PTPs will cause premature yield decline. However, the strong profitability of the crop means that it will remain sustainable even with a significant yield decline. 30. Under the completed projects, the Bank support for rubber has been small, comprising new planting on 6,100 ha and the rehabilitation of a further 16,200 ha, a rather small area in comparison with the total rubber area of 3.5 million ha in Indonesia. All of the Banksupported area was owned by PTP II and was provided for under a single project, TA No. 50- INO:North Sumatra Rubber and Oil Palm Project. Direct support for smallholder rubber was only provided under later projects which are still under implementation. The PTP II has achieved good yields of 1.5 to 2.0 t per ha of rubber which are comparable to plantation yields elsewhere in Indonesia and double those achieved by the PTP prior to the Bank s involvement. In view of oil palm s higher profitability, some of the rubber areas have been replaced by oil palm, and further replacement is expected in the future as the rubber trees age. 31. The single project for cocoa and coconut, the Nucleus Estate and Smallholder Cocoa/Coconut Project (Loan No. 910-INO), substantially failed to achieve its area targets. Overestimation of the suitability of the selected site at the time of Project planning, problems with pests and poor management during planting resulted in less than 30 percent of the 9,100 ha of cocoa and none of the coconut being established. The initial smallholder yields have been higher than the nucleus estate. However, all yields have been low, less than 500 kg per ha of dried beans due to infestations with pod borer and insufficient fertilizer application. Pod borer presents a major and difficult to overcome obstacle to improvement of the Project and further cocoa development in the area. Non-project supported smallholders in the same province obtained much higher yields of up to 1.5 t per ha of dried beans, but these yields are for areas not yet infested with pod borer. A private estate in the same area experienced poorer crop establishment and had similar, low yields as obtained in the Project area.

16 xi 32. The Nucleus Estate and Smallholder Cotton Project (Loan No. 517-INO), implemented in South Sulawesi, was the Bank s only project for cotton. Although the area targets were initially met, they were not sustained. The Project design assumed that yields would increase from the preexisting level of 1 t per ha to 1.5 t per ha. However, average yields over the expanded crop area were much lower while production costs were high due to pest problems and the need for expensive control measures. Compared with before the Project, farmers currently achieve about half the yield, i.e., 0.5 t per ha of seed cotton, and the area of cotton is less. Cotton requires significantly more purchased inputs than alternative crops and is thus more risky under rainfed conditions. Where irrigation is available, farmers prefer to grow rice which generates a higher net income. The Bank-financed East Java Sugar Project was not reassessed for this study. The Project Performance Audit Report, prepared in 1981, noted that rice was more profitable for smallholders than sugarcane which caused underachievement of area and output targets in one of the Project areas. 33. In addition to site specific developments, two of the Bank s projects had components which were of national scope. The North Sumatra Rubber and Oil Palm Project helped improve the capability of the Research Institute of North Sumatra Planters Association for leaf analysis and fertilizer need determination. This facility has been used by all the PTPs, although the interpretation and implementation of the results have not always been done properly. Under the National Estate Crop Protection Project, biological controls were developed for the rhinoceros beetle pest of oil palm and coconut, white root disease of rubber and the coffee borer and have benefited producers in many parts of Indonesia. 34. The initial experience from the ongoing projects utilizing the PMU approach to develop existing smallholders suggests that the expected output targets may not be fully achieved. Smallholders do not use high input, high output production systems. Further, the prevailing market system discourages high quality by using only product weight to determine crop value.11 Consequently, some of the appraisal assumptions regarding beneficiary participation, the effectiveness of extension services to cause change in production systems, and Project yields appear overoptimistic at this stage. The replanting program where trees of low productivity are replaced by higher yielding varieties is expected to give the best results. However, there are indications of variable quality in tree establishment and maintenance. There also are doubts that the developments will be adequately supported at the end of the project implementation period. After project completion, the provincial staff must take over the smallholder support functions using their regular budget which is generally inadequate to maintain the level of services provided under the PMU The advantage of using only weight is its simplicity: the need to negotiate over quality characteristics is eliminated and separate receiving bins for different quality grades do not have to be kept. Traders claim that before higher prices can be offered for better qualities, they would have to receive large volumes of the better grades to justify keeping the grades separate and to enable them to sell the better grades as a separate lot. This would require simultaneous change to producing better grades by many smallholders. 12 The issue of long-term support is expected to be reviewed under an advisory TA for sustainable project management for tree crop development planned by the Bank and the Government.

17 xii 2. Agro-Processing 35. Under the completed projects, the Bank supported eight oil palm mills with an aggregate capacity of 280 t per hour of FFB, and a small oil palm refinery. A further two mills with 120 t per hour of FFB milling capacity are supported under the ongoing Project of Loan No INO. The completed mills have been established or rehabilitated using technology that was appropriate at the time, and which is still suitable. In only a few instances were design deficiencies evident, namely, undercapacity in parts of the kernel recovery plants, the use of weak chains which are prone to frequent breakage in the fruit elevators, and in the Sei Buatan mill, overcapacity in the presses. The standard mill design in Indonesia also utilizes decanters which are proving expensive to maintain. 36. The oil palm industry in Indonesia is composed of scattered areas of production, each with its own processing facilities. There are relatively few independent growers and millers such as exist in the more densely planted areas of Malaysia. This is because until 1995, Government required all oil palm mills to establish oil palm plantations to be owned either by the mill or by smallholders around the mill. Therefore, it was important for each project to establish the correct balance between production and processing. In this aspect, the Bank s oil palmbased projects have not fared well as underutilization of the mills is a common feature (see para. 37). The reasons for underutilization include both overoptimism of appraisal expectations about crop yields, suboptimal production methods including inadequate fertilizer application and the harvesting of unripe fruit, and the project approach whereby all the processing capacity is installed during the 5-6 year implementation period (see para. 64). Underutilization of capacity does provide scope for increases in smallholder and PTP oil palm areas, however. Although not a major problem due to the distance between mills, there have been cases where private mills have attracted fruit from the NES smallholders by offering better prices than the PTPs. In this aspect, the PTPs have less flexibility in modifying their prices or terms to compete against the private sector. 37. Of the six oil palm mills reviewed as part of this IES, only one, established at Sei Garo under the Second Nucleus Estate and Smallholder Oil Palm Project (Loan No. 789-INO), had been operating close to its capacity (see Appendix 7). The throughput of the other mills has generally been unsatisfactory, at less than 75 percent of capacity over the five-year period of 1991 to The Sei Buatan mill (Nucleus Estate and Smallholder Oil Palm [Loan No INO]) throughput has been less than 50 percent of its capacity. The extraction rates were between 20 and 22 percent for crude oil palm and between 4 and 5 percent for palm kernel. These are similar to rates achieved by other PTP mills, but are less than the rates of 24.5 percent for crude palm oil and 5 percent for palm kernel achieved by the better private Indonesian mills. Both oil and kernel losses appear quite high for the Bank-supported mills. The reasons for underperformance are the harvesting of unripe fruit, lack of balance between processing capacity and farm production, inadequate kernel recovery plants, and poor management. Poor management reduces peak operating capacity and this can cause some fruit to spoil during the peak harvesting periods. Poor management also contributes to losses, such as, from failure to maintain the automatic sterilizer system resulting in incomplete removal of fruitlets from the bunches, the nonrecovery of fruit from bunches prior to incineration, and poor control of temperatures in some parts of the mill which reduces oil recovery.

18 xiii 38. The Sawit Sebarang oil palm refinery operates below capacity, producing about 30,000 to 50,000 t of product per year, compared with its rated capacity of 60,000 t per year. The plant and equipment were well designed and installed. The low throughput is mainly because PTP II obtains higher profit from selling its oil palm output in crude form than as a refined product to domestic wholesalers. The small size of the refinery limits the ability of PTP II to develop a brand name which would enable it to obtain a higher price by selling refined cooking oil to retailers in competition with established private operators. 39. Rubber processing facilities were included in only one of the completed Bank projects, the North Sumatra Rubber and Oil Palm Project. The expansion and new works for the two crumb rubber factories and one latex factory were satisfactorily completed. They operate at about 20 to 40 percent capacity, however, due to lower than expected raw material availability. Consequently, production costs are high. The shortfall in raw material supply results from unfulfilled expectations about rubber expansion, and the conversion of some of the rubber areas to oil palm due to high losses of rubber trees from wind damage and the higher profitability of oil palm. The ongoing Smallholder Tree Crop Processing Project also supports smallholder rubber processing and four crumb rubber factories. The smallholder units are intended to enable smallholders to produce dry sheets rather than unprocessed lump rubber which they have been producing in the past. However, slow adoption has occurred due to the absence of a clear incentive, in the form of higher prices, to produce the sheets. 40. The ginnery for processing cotton provided under the Nucleus Estate and Smallholder Cotton Project was satisfactorily established, but in recent years has operated for only a few weeks per year due to the decline in cotton production in the area. A nearby mill which existed prior to the Project also operates for only a few weeks per year. Processing facilities for cocoa, operated by the NES, were included under the Nucleus Estate and Smallholder Cocoa/Coconut Project. A price premium is not received for fermented beans and, therefore, the processing involves simple sundrying without fermenting. Wood fired dryers were also established but taint the cocoa beans and are not used anymore. The expected large inflow of beans from smallholders also has not occurred due to low output and the sale by smallholders of the majority of their beans to private traders who pay higher prices than the nucleus estate. One of the two sugar factories supported by the Bank in East Java also suffered from low operating throughput due to inadequate supplies of cane. 3. Industry Policies and Structure 41. The main impact on the policy environment has come through the Bank s TA activities and has concerned oil palm. The recommendations of TA No INO:Pricing and Distribution Policies for Vegetable Oil and the subsequent outputs of a staff consultant to formulate a vegetable oil policy were embodied in the deregulation package for vegetable oils implemented in Among the features of this package was the termination of import and export controls on oil palm and the use of market forces to determine the price of oil palm in the