Confusing signals

Set against the spirit of deregulation which has long been the hallmark of the Indonesian government, the recent official comments on the protection of petrochemical plants are ringing out confusing signals. Minister of Investment Sanyoto Sastrowardoyo has guaranteed tariff protection for the US$ 1.6 billion olefins industry of PT Chandra Asri. However, Coordinating Minister for Economy and Finances Saleh Afiff and other economics ministers, such as Minister of Industry Tunky Ariwibowo and Minister of Finance Mar'ie Muhammad, contend that the government will not provide protection indiscriminately for all new industrial plants, let alone upstream industries, because such a measure will affect downstream industries.

Earlier in June, when the latest package of deregulation measures was launched, the government explicitly ruled out import tariff escalation for the products of new industrial ventures.

Tariff protection for petrochemicals would surely affect the whole manufacturing industry because those materials are used not only for making plastics and synthetic fibers but also for numerous other products. We can hardly mention a single manufactured product that does not use plastics either as parts or components or packaging materials. That is why any tariff protection for this industry, especially when the protection is granted without specified time limits, raises so great a concern.

The arguments for justifying tariff protection for petrochemicals are classic: big contribution to deepening the roots of the manufacturing industry, big investment, high technology, high capital costs due to high interest rates, saving of foreign exchange, extra spending on basic infrastructure and long gestation (pay-back) period.

But industrial users of petrochemicals contend that domestic producers actually need no tariff protection provided they can produce as efficiently as their counterparts overseas and if their debt-equity ratio does not exceed the commercially viable level. In fact, domestic plants enjoy advantages in the form of cheap raw materials (hydrocarbons). Moreover, even if local products are 10 to 15 percent more expensive than imports, industrial users still prefer local suppliers as local procurement can minimize storage costs through just- in-time deliveries.

The first question then is why upstream petrochemical producers demand protection. The answer can be traced to the gross inefficiency of domestic producers. Their capital costs are unusually high. This is not only because they often have to bear the costs of basic infrastructure but mainly because the owners often depend almost entirely on borrowing to finance their projects. Past experience shows how sponsors have often marked up their investment requirement to gain larger-than-necessary loans because part of the loans were used for putting up their equity capital.

The next question is why the government has given protection to almost every new petrochemical plant and will most likely provide similar treatment to new ones. The answer lies partly in the government's determination to strengthen the structure of the manufacturing industry, sometimes without full consideration of the costs. Another factor is a dilemma the government often encounters. Without protection, domestic petrochemical producers will surely not be able to compete with imports and will encounter trouble with repaying their big debts to banks. That may cause another big wave of bad debts, given the extensive exposure of major banks, including state banks, to petrochemical projects.

We even get the impression that the current rush to build petrochemical projects, despite the prediction of a market glut by almost all international analysts based on the huge capacity expansions in South Korea, Taiwan, Singapore, Thailand, the Middle East and China, has been prompted by the official commitment to giving investors protection.

Another reason behind the government's "generosity" may be found in the names of the investors. The upstream and intermediate petrochemical plants already producing and those still under construction are owned by only a few business groups, which are controlled by tycoons with strong political connections. In fact, the various petrochemical companies are all inter-linked with each other through cross-share ownership.

Then, if it is almost certain that the olefins industry and other projects, such as the planned aromatics plant, will get tariff protection, what is the point of our arguments? In fact, the point is little more than taking the opportunity to express our hopes. Those being that the protection will not be very high, will be given only after thorough investigations into the structure of the costs of the producing companies, and granted only for a specified period of time.