INDONESIA - POVERTY RISES DESPITE SOUND MACROECONOMIC

UNCLAS SECTION 01 OF 03 JAKARTA 000031 SIPDIS SIPDIS SENSITIVE DEPT FOR EAP/MTS AND EB/IFD/OMA TREASURY FOR IA-SETH SEARLS COMMERCE FOR 4430/SBERLINGUETTE AGRICULTURE FOR JDEVER AND ACHAUDHRY AND PSHEIKH STATE PASS TO USTR FOR DKATZ E.O. 12598: N/A TAGS: EFIN EINV ECON ETRD ID SUBJECT: INDONESIA - POVERTY RISES DESPITE SOUND MACROECONOMIC ENVIRONMENT A) Jakarta 13326 ¶1. (SBU) Summary. In an embarrassment for the Yudhoyono Administration, the incidence of poverty in Indonesia has risen over the past year from 16 to almost 18 percent despite the return of macroeconomic stability and GDP growth rates above five percent. Most analysts attribute the increase in poverty to two factors: the structure of poverty in Indonesia and how it is measured; and the high price of rice. Forty-nine percent of the population earns less than $2 a day and 17% earns less than $1.55 a day (the national poverty line). Rice accounts for nearly a quarter of expenditures for most low income Indonesians, and its wholesale price has risen 70 percent over the past two years in response to economy-wide inflationary pressures, poor harvests, Government of Indonesia (GOI) rice price policy, and GOI restrictions on rice imports. The 2007 budget targets poverty alleviation and reduction through a variety of programs to encourage economic growth, increase employment and provide better services to the poor. Nonetheless, the quickest way to reduce poverty levels would be to increase employment, which is unlikely without significant new investment, especially in labor intensive sectors such agriculture, manufacturing and infrastructure. With investment climate reforms proceeding at a modest pace, few analysts expect the Yudhoyono Administration to meet its own target of reducing the incidence of poverty to 8.2% of the population by 2009. End Summary. Macroeconomic Stability Fails to Reduce Poverty -------------- -- ¶2. (U) The GOI successfully restored macroeconomic stability in 2006, following the economic "mini-crisis" of 2005 (reftel). Forecasters predict that the Indonesian economy will expand by 5.5% in 2006 and by close to 6.0% in 2007. Moreover, Bank Indonesia expects that headline inflation will fall below 6% for the full year 2006, down from over 18% YoY in October and November 2005, when the GOI reduced fuel price subsidies. The Rp/USD exchange rate has also stabilized, remaining close to the 9000-9300 Rp/USD range for most of the past nine months. ¶3. (U) Despite this hard won stability, both income and non-income (i.e. access to social services and infrastructure) poverty among Indonesia's population has risen over the past year. After declining steadily in the years following Indonesia's 1998 economic crisis, the poverty headcount rose from 16.0% in 2005 to 17.8% in ¶2006. Most analysts attribute the rise to two factors, the structure of poverty in Indonesia, and the high price of rice, which has risen steadily over the past two years in response to poor harvests and GOI restrictions on rice imports. Structure of Poverty in Indonesia is Key Challenge -------------- -------------- ¶4. (U) According to a recent World Bank report, almost 17% of Indonesia's population is living below the national poverty line of $1.55 a day. However, another 32% of the population hovers near the national poverty line, living on between $1.55 and $2 a day, bringing the total percentage of poor and near poor to close to half the population. According to the same report, there also is a high degree of movement in and out of poverty over time in Indonesia. More than 59% of Indonesians had been poor at some time during the year in 2003, and over 38% of poor households in 2004 were not poor in 2003. As a result, small changes in prices of consumer goods, income, and employment rates have a very significant impact on the official rate of poverty in Indonesia. ¶5. (U) The WB study also points out that large numbers of Indonesians experience various forms of non-income poverty such as a lack of access to adequate education, quality healthcare services and other basic infrastructure. Indonesia continues to lag behind other countries in the region in maternal health, child nutrition, levels of education, and access to safe water and sanitation. For example, Indonesia's maternal mortality rate (307 deaths in 1000,000 births) is three times that of Vietnam and six times that of China and Malaysia. ¶6. (U) Finally, regional disparities hamper Indonesia's ability to stem increases in poverty. According to the World Bank study, although the largest number of poor in Indonesia lives in the densely populated islands of Java and Bali, the incidence of poverty in those areas is relatively low at 15.7% of the population. In contrast, more remote areas such as Papua are home to only 3% of JAKARTA 00000031 002 OF 003 Indonesia's poor, but the incidence of poverty in Papua is 38.7%. In addition, access to services varies greatly across Indonesia, with more remote areas suffering disproportionately. As a result, one-size-fits-all poverty programs have limited success in reducing the number of poor among disparate sections of the country. Spike in Rice Prices Impacts Poverty Headcount -------------- - ¶7. (SBU) Because a large portion of Indonesia's population is vulnerable to falling into poverty, the steady increase in Indonesia's retail rice prices has had a significant impact on poverty rates in Indonesia. Rice accounts for nearly a quarter of expenditures of most low income Indonesians, making it the single most important commodity in the fight against poverty. According to the leading Jakarta rice distributor, wholesale rice prices rose 27% from November 2005 to November 2006. This jump followed a 33% increase in the price of rice during the previous twelve months. Poor harvests, restrictions on rice imports, and failed government policies are responsible for the sharp increase in the price of rice. (Note: While rising fuel prices drove the dramatic increase in headline inflation in 2005 and 2006, many analysts believe the increase in fuel prices did not directly impact poverty rates in Indonesia, because the poor received cash transfers to compensate for the higher prices. In addition, middle and upper income Indonesian's are the most significant consumers of fuel in the country. End Note.) ¶8. (SBU) The GOI sets a minimum rice price at which local cooperatives can purchase rice on behalf of the State Logistics Board BULOG. Rice farmers may sell their stock to BULOG, through cooperatives, or to private sector wholesalers. In practice most farmers sell to private distributors, which generally offer more attractive prices. However, few rice farmers benefit much from increases in the retail price of their crop. In 1998, the GOI increased the floor price for wholesale rice without an accompanying increase in the floor price for wet paddy rice paid to farmers. The resulting gap has made it difficult for farmers to afford to purchase retail rice, since retail rice prices track wholesale prices. In addition, since most rice farmers in Indonesia are small-scale, they lack the capacity to store the rice they produce and must sell their rice when supplies are higher instead of taking advantage of the natural increase in prices during the non-harvest season when supplies are lower. Wholesalers are the winners in this system--they buy at low prices from farmers during the harvest season, and sell high into the tight market that results from the import ban as well as GOI price policy for wholesale and wet paddy rice. ¶9. (SBU) BULOG is required to maintain a stock of rice for distribution to the poor or victims of natural disasters at subsidized prices. BULOG also releases its stock at the behest of the government under the Rice Market Operation (MO) policy, in order to stabilize prices. The GOI currently prohibits BULOG from importing rice unless its stock falls below 1,000,000 tons. However, in late 2006 the GOI's MO policy has failed to bring price relief. As a result, the price of rice continues to rise, jumping close to 8% during the first three weeks of December because stocks of rice in general have been depleted and planting has been delayed. Drought is also expected to delay the 2007 rice harvest until April or May on Java Island, where about half of the rice in Indonesia is produced. GOI Infighting Over Rice Import Ban Ebbs -------------- ¶10. (SBU) Minister of Trade Mari Pangestu and other GOI Ministers have supported lifting a GOI ban on rice imports from countries like Thailand and Vietnam to help stabilize prices. Until recently, however, Minister of Agriculture Anton Apriyantono, a member of the Prosperous Justice Party (PKS),has largely stymied Pangestu's efforts. The PKS, a member of the GOI coalition government, is a conservative, Islamist grouping, with a relatively small, but growing rural political base. Anton, with support from rice distributor and growers groups, argued vehemently over the past two years that there was no shortage in Indonesia's rice stocks and that allowing rice imports would hurt local farmers that could not compete with lower import prices. At times, Anton and others have even gone as far as to intimate that Pangestu's ethnic-Chinese lineage was behind her interest in allowing rice imports (many rice traders are Chinese Indonesians). JAKARTA 00000031 003 OF 003 ¶11. (SBU) The most recent dramatic spike in rice prices and a World Bank report recommending the GOI lift its import ban have apparently provided the GOI with enough political cover to ease the ban and allow some imports. Coordinating Minister Boediono told a group of donors and business representatives on December 18 that the GOI is working to stabilize rice prices and will "do whatever it takes" to normalize the situation. On December 26, the GOI announced plans to import 500,000 tons of rice during January and February 2007 in an effort to distribute 600,000 tons of rice to the poor over the next few months. Nevertheless, the unusually long dry season in 2006 delayed rice planting and most observers expect this year's harvest to be poor, putting renewed pressure on rice prices. Limited Employment Growth Keeps Poverty Rates High -------------- -------------- ¶12. (U) As noted above, analysts expect Indonesia's economy to expand a healthy 5.5% this year. However, growth in labor intensive industries, such as agriculture and manufacturing, have failed to keep pace, keeping unemployment levels high and contributing to high rates of poverty (reftel). According to BPS, the unemployment rate in Indonesia has remained steady in 2006, at roughly 10%. Increasingly Pro-Poor Policies But Challenges Remain -------------- -------------- ¶13. (U) In order to address income and non-income poverty issues and meet its ambitious poverty reduction goal of 8.2% by 2009, the GOI has proposed a 2007 fiscal budget that focuses on economic growth, increased employment, and poverty reduction. The GOI increased the 2007 budget for the Ministry of Health and the Ministry of Education by 20% and 10% respectively in an effort to improve health and education services provided to the poor. In addition, the 2007 spending policies for almost all line ministries include some element of pro-poor policies, including assistance to labor intensive industries, and subsidies for kerosene, fertilizer, and seed purchases. The GOI also increased its total social assistance budget from Rp 36.9 trillion ($4.1 billion) in 2006 to Rp 49 trillion in 2007 ($5.4 billion). Of the Rp 49 trillion budgeted for general social assistance, the GOI allocated Rp 47 trillion ($5.2 billion) to social assistance for the poor, compared to only Rp 26.5 trillion ($2.9 billion) in 2006. ¶14. (U) The GOI also will replace its current unconditional cash transfer program with a Rp 4 trillion conditional cash transfer program in 2007. The new program, which focuses on maternal and child health and education, will require recipients to provide evidence that they used the funds to obtain the intended health and education services. For example, children receiving educational stipends will be required to maintain an attendance record of 85% or higher. Finally, in addition to the recently announced GOI initiative to import 500,000 tons of rice for poor families listed above, the 2007 budget includes a Rp. 6.8 trillion rice subsidy program targeted at providing subsidized rice to roughly 16 million poor households. ¶15. (SBU) Comment: Although the Yudhoyono Administration is working hard to improve the pro-poor orientation of the budget, the total amount of funds for poverty alleviation is small and most GOI anti-poverty programs will take years to roll out. As a result, the SBY Administration is unlikely to meet the poverty reduction goals it announced as part of its 2005-09 Medium Term Development Plan without sustained growth in agriculture and other labor intensive sectors. In fact, the primary motivation behind SBY's very prominent biofuels initiative is just this--to increase employment in rural areas through the development of massive palm oil plantations and their associated infrastructure. The GOI will also need to follow through more aggressively in implementing promised investment climate reforms to increase private investment throughout the economy. In addition to increasing employment, the best short term policy option available to drive down poverty rates would be to allow sufficient rice imports so that retail rice prices fall to more reasonable levels, a message the GOI seems to finally be learning. HEFFERN