Indonesia's palm oil subsector

A recommendation: Indonesia should repeal its export tax on crude palm oil and discontinue buffer stock operations and directed sales from public estates. It is time for Indonesia to complete the evolution from public interventions in the palm oil market to private sector initiative in response to international price signals.Debate on Indonesia's palm oil policy was stimulated by a sharp increase in cooking oil prices in 1994-95 and a resulting increase in the export tax rate on crude palm oil. Palm oil has been one of the fastest growing subsectors in Indonesia. In two decades, annual output grew from less than 400,000 tons to more than 4 million. Using a quantitative model, Larson analyzes the effect of government policies, including the export tax, buffer stock operations by the BULOG (the national logistics agency), and directed sales from public estates.Larson acknowledges the export tax's effectiveness in lowering domestic prices, but observes that its impact on inflation and consumer welfare is minimal. Cooking oil accounts for only 1.4 percent of the consumer price index and welfare gains to consumers are small (less than $1 per capita annually) because the importance of cooking oil has declined in the household budget of even the poorest households. (It is 4 percent of the household budget of the poorest 20 percent of the rural population.)The tax has also had the unintended effect of transferring income (up to US$99 million a year) from oil palm growers - 22 percent of them smallholders - located primarily off Java.The structure of the tax discourages local processing by squeezing margins for processing. And determining tax rates on palm oil products independent from the underlying crude palm oil price creates uncertainty about marketing margins for processors, inhibiting effective risk management.Larson recommends repealing the tax. He also recommends discontinuing buffer stock operations and directed sales from public estates because they are ineffective at lowering domestic prices and affect investment by creating needless uncertainty.Larson concludes with recommendations on investment policy. Direct incentives (in the form of subsidized loans) to private investors have been an indirect instrument for overcoming investment risks and uncertainties, but investors should no longer need those incentives.Instead, Indonesia's government should focus more on alleviating obstacles to private investment, such as lack of rural infrastructure, land titles, and sovereign risk. The Bank might be of assistance in this area.The review for this paper - a product of the Commodity Policy and Analysis Unit, International Economics Department, and the Agriculture Operations Division, East Asia and Pacific, Country Department III - was conducted to help the debate on Indonesia's palm oil policy. Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Pauline Kokila, room N5030, telephone 2024733716, fax 2025223564, Internet address pkokila@worldbank.org. (47 pages)The full report is available on the World Bank FTP server