Overcapacity in forestry sector

Overcapacity in forestry sector

By Agus Purnomo

JAKARTA (JP): Representatives of the World Bank and bilateral
donor countries met on Wednesday with Coordinating Minister of
the Economy, Finance and Industry Kwik Kian Gie and Minister of
Forestry and Plantations Nur Mahmudi Ismail to discuss the future
of the country's forests.

The seminar, held in preparation for next week's full
gathering of the Consultative Group on Indonesia (CGI), was the
first meeting between the Indonesian government and the donor
community to focus specifically on forestry since the collapse of
the Soeharto regime.

As such, it represents a unique and altogether unprecedented
opportunity for positive change in the country's forestry sector.
Whether the parties involved take concrete steps toward the
sustainable and equitable management of Indonesia's remaining
forest resources will depend on their ability to distinguish
between long-term social and environmental concerns, on the one
hand, and short-term economic gains on the other.

Two critical issues that lie at the heart of our forestry
crisis today are overcapacity in the nation's wood-processing
sector, and corporate debt held by forestry conglomerates.

According to figures from the Indonesia-UK Tropical Forest
Management Program, the combined log consumption capacity of the
plywood, sawn wood and pulp and paper industries is currently on
the order of 75 million cubic meters (m3) per year.

However, the ministry's figures show that the official harvest
averaged just under 25 million m3 per annum over the last few
years. This indicates that these industries have obtained between
one-half and two-thirds of the logs they consume from illegal and
presumably unsustainable sources.

The problem of overcapacity is especially troublesome in the
pulp and paper subsector. Following US$8 billion in investment
over the past 13 years, each of these industries has expanded by
over 750 percent since 1987.

Indonesian pulp producers are currently capable of generating
4.6 million tons of pulp per year, which is equivalent to
processing 22.5 million m3 of roundwood annually.

Pulp production capacity, however, has grown far more rapidly
than development of sustainable pulpwood plantations (HTI). Of
the 100 million m3 of wood consumed by pulp producers since 1987,
no more than 5 million m3 has come from the plantations.

Most of the remaining 95 million m3 has been obtained through
the legal and illegal clear-cutting of natural forests,
accounting for the deforestation of approximately 800,000
hectares. While Indonesia's largest producers are now working to
establish pulpwood plantations, it is extremely doubtful that the
limited areas being planted will yield the volumes of wood needed
to satisfy the industry's growing processing capacity at any
point during the next decade.

Until now, much of the policy dialog aimed at addressing the
problems of illegal logging and unsustainable forest management
has focused on improving the practices of companies holding
timber concessions (HPH).

Since late 1997, for instance, the World Bank and the
International Monetary Fund (IMF) have worked with the government
to raise timber royalties so that HPH-holders will manage their
areas more efficiently. They have also sought to deregulate log
exports so that concessionaires are able to obtain international
market prices for the logs they harvest, and to establish an
independent monitoring system for HPHs.

Whatever the merits of these policies, they do little to
rectify the fundamental imbalance between the demand for logs on
the part of Indonesia's wood-processing industries and the
nation's legal and sustainable log supply. Ultimately, the
problem of overcapacity requires nothing less than a substantial
downsizing of the country's wood-based industries.

To a significant degree, the size and structure of Indonesia's
wood-based industries over the coming years will be determined by
the manner in which the nation's corporate debt crisis is
resolved. Through the end of 1999, private corporations have
held Rp 345 trillion ($51.5 billion) in outstanding debt to the
Indonesian Bank Restructuring Agency (IBRA), of which Rp 230
trillion ($34.3 trillion) is nonperforming.

Forest and estate crop sector activities account for 8
percent, or Rp 28 trillion ($ 4.1 billion), of the amount that
companies owe to IBRA. Of this, Rp 18 trillion ($2.7 billion) is
estimated to be nonperforming.

In addition, forest and estate crop conglomerates are carrying
$2.4 billion in domestic nonperforming loans related to
investments in other sectors, and at least $15 billion in
outstanding offshore loans to foreign creditors.

The high level of nonperforming loans held by forest-linked
conglomerates can be attributed to the fact that they have often
been able to obtain finance for their investments with minimal
due diligence.

As in other sectors, state banks frequently made loans to
forest sector projects based on political instructions from
senior government officials rather than prudential calculations
of risk.

Most of the major groups active in the forest and estate crop
industries also owned their own banks, which allowed them to
access much larger sums of finance than they would have been able
to obtain had they been forced to borrow funds from unaffiliated
banks at commercial rates. Many of these group-owned banks
regularly violated the government's legal lending limits for
loans to affiliated parties, and engaged in financial mark-up
schemes to discount the real costs of investment.

Moreover, government subsidies -- including cheap raw
materials and allocations from the reforestation funds further
undermined companies' incentives to ensure that their investments
would be profitable over the long-term.

This has led many forest sector conglomerates to establish
processing operations that are dependent on illegal or
unsustainable raw material supplies, or that have generated
social conflicts with local communities. The closure of the $600
million Indorayon pulp mill in Porsea, North Sumatra, following
community protests last year is clear evidence of the financial
risks that investments in such projects can entail.

Through the banking sector recapitalization process, IBRA has
emerged as the single most important holder or potential holder
of forest and estate crop assets in Indonesia. Two of the
largest forest sector conglomerates -- the Bob Hasan Group and
the Salim Group -- have been in receivership under IBRA since
early last year.

In addition, IBRA has far-reaching legal authority to call in
nonperforming loans and to seize corporate assets of most other
forest conglomerates if they do not pay their debts to banks
under IBRA management. To date, however, IBRA has allowed these
groups' previous owners to continue running their companies with
little direct supervision.

More significantly, there are strong indications that IBRA
will write off at least 70 percent of the nonperforming loans
held by companies under its control. In the forest and estate
crop sector, this would amount to a write-off of Rp 12.6 trillion
($1.9 billion) in bad debt.

If anticipated write-offs of nonforest sector loans incurred
by forest conglomerates are also included, this figure would rise
to Rp 24.2 trillion ($3.6 billion). In effect, debt write-off or
markdown on this scale will amount to yet another heavy subsidy
to Indonesia's timber, wood-processing, pulp and paper and palm
oil companies.

In each of these industries, such a subsidy is likely to
encourage further capital investments in illegal, environmentally
unsustainable and socially damaging projects.

To alleviate pressure on the country's remaining forest
resources, the World Bank, the IMF and the Indonesian government
should work together immediately to hold forestry sector debtors
accountable for their outstanding financial obligations.

Companies that are able to repay their loans should be
required to do so. To the extent that some companies' debts are
written off, this should be linked to the reduction of processing
overcapacity at both the firm and industry levels.

In the meantime, IBRA should incorporate a clear set of social
and environmental criteria into its due diligence process to
ensure that forestry assets under its control are being managed
equitably and sustainably.

The writer is the executive director of the World Wide Fund
for Nature -- Indonesia.