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.