Confusing signals

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.