Executive Summary

Indonesia's forests are internationally renowned for their high biodiversity value. Despite this, the principle that continues to govern their day-to-day use is the market value of the tropical timber they contain. Those granted the rights to harvest and sell timber have in the past earned abnormally high profit, which in the language of economics is called "rent." As a result of these high levels of rent, the sector has been subject to a high level of political interference, particularly from leaders and business figures who wished to gain illicit access to these rents.

Before the reformasi era, the Indonesian government's forestry policy, although on paper aimed at sustainable forest management, in practice allowed those companies who had the rights to harvest, process and export forest products to extract as much rent as possible. There seems to have been an understanding that a substantial portion of the rent earned from this activity would be shared with the former President, not so much through formal channels like government revenue, but through less formal channels, including shares in timber companies, joint business activities, and side payments.

Of the top five private timber concession holders, which between them hold 30 percent of the total area under concession, two (the Barito Pacific and Bob Hasan groups) have given directorships and shareholdings in timber concessions to Suharto family members, and more importantly, financed billions of dollars worth of the family's business activities. Two (the Alas Kusuma and Kayu Lapis Indonesia groups) are less political in this sense. The fifth group (Djajanti) is an intermediate case. The remaining top-twenty timber concession holders are also roughly evenly divided between political and less political companies. The Department of Forestry's recent closure, or non-renewal, of a handful of concessions assigned to these large groups will not dislodge them from their position at the commanding heights of the timber industry.

Because log exports have been prohibited since 1985, and rough sawn timber exports prohibited since 1992, the main avenue for timber companies to capture rent is through the export of plywood. The same top-five companies that dominate in terms of concession holdings have obtained a similar market share in plywood factories. The only exception to this rule is the Bob Hasan group, which was until recently able to capture plywood rents in a more direct fashion, through the position of its chairman at the helm of the Indonesian plywood producer's association (Apkindo).

Because the harvesting and processing of timber for export (which generated high rents for favored individuals) preoccupied Indonesia's senior policy makers, less attention was paid to issues of supply and demand. During the period covered by this study, 1994 to 1998, 20 percent of the nation's timber concessions were closed down, resulting in a decrease in available supply. At the same time, permission was granted to the saw- and ply-milling sectors to increase consumption by 10 percent. As a result, the ability of the nations' HPH-linked plymills and sawmills to supply themselves from their own concessions fell by 10 percent.

The growing demands on a shrinking pool of timber from the nation's concessions is increasingly being made up for by illegal logging. The magnitude of the contribution of illegal logging to national timber supply is arrived at by taking the total annual consumption of Indonesia's sawmills and plywood mills, and subtracting from that the annual legal roundwood production of the country's timber concessions, and of all government approved land-clearing. The resulting number is an estimate of the amount of illegal logging currently sustaining the plywood and sawn timber industries. This report excludes the pulp and paper sector, which is more difficult to understand because of the complex issue of waste paper imports.

The bare minimum amount of illegal felling necessary to maintain the operations of the nation's plywood mills and sawmills remained at 20 million cubic meters throughout the duration of the study. While the amount available from the selective felling of natural forests fell from 18 million cubic meters to 16 million cubic meters over this period, the legal but unsustainable clear-felling of natural forests, increased from an annual rate of 5 million to 10 million cubic meters a year, over the same period. Such land clearing is said to be necessary in order to make room for the planting of industrial timber and palm oil estates, and is even thought to be practiced on some of the 130 timber concessions closed down by the government and turned over to the five state-owned Inhutani forestry corporations for the purposes of "rehabilitation." However at best - and this only in the case of industrial timber plantations - only 25 percent of the land cleared is replanted for its intended purpose.

In the aftermath of thirty years of rent-seeking, and with both illegal and non-sustainable logging on the rise, the Department of Forestry has responded with two sets of reforms that are quite different from one another. The first reforms amount to a new form of timber patronage, placing limits on the future concession holdings of timber groups, and decreeing that timber resources be shared with cooperatives.

Based on the findings of a previous ITMFP report, it is thought that new size limits of 50,000 hectares per concession, and 100,000 hectares per province, will have a negative impact on the ability of concessionaires to either operate efficiently and sustainably, or to pay a fair rent to government, and should therefore be rescinded.

The new nationwide limit-per-group of 400,000 hectares will have no discernible impact on the profitability of those groups, or their ability to pay rent to the government. However, the new size limit could have implications for the sustainability of the country's forests. The 28 groups whose holdings are currently in excess of 400,000 hectares will have to divest themselves of all holdings which put them in excess of that limit when those particular concessions come up for renewal. If companies have to reduce the sizes of their holdings, they will try to keep their best, and give up their worst, and this gives an incentive for them to destroy the timber concessions they plan to give up.

The granting of small timber concessions to cooperatives should also be reconsidered, not only because it could be used for the diversion of timber rent to politically-favored recipients, but also because the experience of Sabah, Malaysia with small short-tenure timber concessions suggests that such units are not sustainable.

The second set of policies -- pursued by the Department of Forestry in conjunction with the World Bank -- could not be more different from the first. They constitute an effort to introduce price levels and incentives that will lead to greater sustainability in the timber industry. The policies entail: (1) removing distortions so domestic timber prices can be raised to the level of world prices, and once prices and potential rent are high, capturing as much of that rent as possible through (2) the auction of timber concessions, (3) area-based stumpage fees, and (4) posting performance bonds.

To quantify the importance of these policies, if distortions were removed from the pricing of Indonesian logs, it is reasonable to assume that a cubic meter of red meranti, the industry standard, would sell for US$80, an average of its currently-too-low domestic price of US$50 and its normal international price of US$110. The rent for a cubic meter of red meranti selling at US$80, once the cost of extraction of US$17, and normal profit of US$5 are subtracted, would be US$58. That US$58 in rent could be totally captured by the government, with concessionaires paying US$5/cubic meter in auction fees, US$35 in area-based stumpage fees, US$16 for performance bonds, and the remaining US$2 going to corporate income tax.

However, as things stand now, this is not happening. First, prices continue to be too low in the Indonesian market, not only because the government is keeping in place non-tariff barriers, but also because the domestic market is flooded with illegal logs. This makes it impossible for domestic wood prices to rise to the level of world prices. Second, in spite of having passed a law a year ago to make auctions possible, the government maintains that, when and if auctions do happen, concessions will not be awarded to the highest bidder, but rather to the company which best satisfies as-yet-to-be-specified criteria of the Department of Forestry. Third, in spite of agreeing to refine the resource rental taxation formula by April, 1999 to ensure that 60 percent of timber rent (US$35) is captured, timber revenues continue to capture barely over half that amount (US$20).

While the present government's new patronage agenda should not be rejected out of hand, nor its more market-oriented commitments wholly embraced, the less effort that is expended on politically engineering the redistribution of timber rent, and the more that such redistribution is allowed to take place through transparent, market-mediated mechanisms, the better.

This report recommends concessions no longer be discretionarily distributed by the government to politically favored parties, but auctioned to the highest bidder. The government should stop trying to depress the local price of timber, as this only results in powerful companies buying logs at cheap prices, turning those logs into plywood, which is sold for astronomical profits on the world market with little benefit accruing to the people of Indonesia. Instead, this report recommends the government craft timber revenue policies that allow it to capture the enormous rent embodied in the nations' timber resources, so that these proceeds can then be used to help the nation as a whole. Timber revenues should be set on an area basis, so that valuable timber is removed, rather than being left for illegal loggers to steal. Finally, the report recommends that timber concessionaires be required to post performance bonds, revocable in the event that they do not log responsibly.

September 7, 1999