VZCZCXRO5692
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #0286/01 0430847
ZNR UUUUU ZZH
R 120847Z FEB 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 7966
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHRC/USDA FAS WASHDC
RUEHKO/AMEMBASSY TOKYO 1513
RUEHBJ/AMEMBASSY BEIJING 4716
RUEHBY/AMEMBASSY CANBERRA 1991
RUEHUL/AMEMBASSY SEOUL 4395
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 000286 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA-SETH SEARLS AND JWEEKS 
SINGAPORE FOR SBAKER 
TOKYO FOR MGREWE 
COMMERCE FOR 4430/BERLINGUETTE 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN 
DEPARTMENT PASS EXIM BANK 
USDA/FAS/OA YOST, MILLER, JACKSON 
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER 
USDA/FAS/OGA CHAUDRY, DWYER 
 
E.O. 12598: N/A 
TAGS: EFIN EAGR ECON PGOV ID
SUBJECT: SOARING FOOD PRICES PROMPT LARGE STABILIZATION PLAN 
 
 
¶1. (SBU) Summary.  Upward pressure on food prices in Indonesia is 
unlikely to subside in their near term, presenting considerable 
hardship for poor households. In an effort to combat food price 
inflation, the Government of Indonesia (GOI) announced a large-scale 
food price stabilization program.  The program includes significant 
price subsidies, a reduction in import duties, a continuation of 
export duties, and incentives to increase and diversify crop 
production.  The new program will have a substantial short- and 
potential long-term impact on government finances and policies. 
Analysts also question the sustainability and effectiveness of price 
subsidies to control inflation in Indonesia.  End Summary. 
 
Pressure on Food Prices Unlikely to Abate 
----------------------------------------- 
 
¶2. (SBU) Pressure on food prices in Indonesia is unlikely to subside 
in their near term due to a host of international and domestic 
factors.  A drought in Australia, other weather-related problems in 
the United States, Canada and Europe and a reduction in planted 
areas in the developed world have reduced global yields of wheat and 
soybeans.  Demand for alternative energy sources has prompted 
farmers to increase corn and palm oil production for biofuel use at 
the expense of crops for human consumption.  Land use policies that 
limit the size of plots available to individual farmers keep larger 
and more efficient farms from forming.  The GOI approval process for 
hybrid seeds that could increase yields is extremely slow; the 
approval process for bioengineered seeds is worse.  Indonesia's 
aging irrigation systems and poor rural infrastructure also limit 
the farmers' ability to respond to increased demand. 
 
¶3. (SBU) Most analysts note that high food prices will eventually 
prompt supply side adjustments that bring food price inflation under 
control.  However, this adjustment process may be slower than in 
previous cycles, particularly in Indonesia.  While observers expect 
the Chinese and Indian economies to cool in the wake of the decline 
in US growth, most also expect food demand from those countries to 
remain robust.  High oil prices will keep the demand for alternative 
energy sources elevated.  Also, significant land and seed policy 
changes and large levels of investment in rural infrastructure in 
Indonesia are unlikely. 
 
Food Costs Exacerbate Poverty Levels 
------------------------------------ 
 
¶4. (SBU) Soaring food prices put significant pressure on Indonesia's 
poor and near poor, a group that represents over 40% of the 
population.  Staple foods, such as rice, soybeans, and palm oil 
(used for cooking), which are now relatively high priced, comprise 
roughly 50% of these families' household budgets.  Moreover, as food 
prices rise, the quality of food products available to poor families 
usually deteriorates, contributing to health problems.  Anecdotal 
evidence suggests that last year's spike in rice prices forced poor 
families to consume rice containing mold and other contaminants. 
High rice prices are responsible the use of so-called "recycled" 
rice by low-income consumers, basically rice recovered from 
restaurant dust bins.  Recent data suggest that higher food and 
energy prices have prompted stronger overall inflation in Indonesia. 
 Headline inflation rose to 7.4% (YOY) in January, up from 6.6% 
(YOY) in December.  The month-on-month increase in prices from 
December to January was 1.8%, up from 1.1% the previous month.  If 
inflation expectations begin to rise, calls for wage increases, 
which put further pressure on prices, could also intensify. 
 
Large-scale Stabilization Plan Announced 
---------------------------------------- 
 
¶5. (SBU) The Yudhoyono government is under significant pressure to 
get food prices under control or risk significant backlash at the 
ballot box in 2009.  GOI contacts have told us that this is one of 
the Yudhoyono administration's top priorities leading up to 
elections.  On February 4, Deputy Chief for Coordination of 
Agriculture and Marine Resources Bayu Krisnamurthi announced a host 
 
JAKARTA 00000286  002 OF 003 
 
 
of new and ongoing policies designed to stabilize food prices.  The 
policies include soybean price subsidies for small-scale producers 
(Rp 1,000 per kg), rice price subsidies (Rp. 1,600 kg) for 15 kg of 
rice per household per month, and cooking oil price subsidies (Rp. 
2,500 per liter) for poor families.  In addition, the GOI will 
temporarily eliminate import duties on flour and soybeans, and lower 
import duties on rice to Rp 450 per kg from Rp 550 per kg.  The new 
policies also relax import standards for wheat. 
 
¶6.  (SBU) The stabilization plan includes provisions to raise the 
export tax for palm oil and derivative products from 10% to 15% and 
expand the categories of cooking oil eligible for government-paid 
value added tax for domestic sales.  The GOI also announced policies 
to accelerated the provision of high quality seeds and promote the 
development of wheat alternatives. 
 
Fiscal Cost High 
---------------- 
 
¶7. (SBU) The total cost of the program and its financing remain 
unclear.  On February 5, Indonesia's Energy Minister Purnomo 
Yusgianoro stated that the GOI would shift Rp 25 trillion ($2.8 
billion) in budget funds, previously allocated for fuel and 
electricity subsidies, to fund new food price subsidies.  The 
Ministry of Energy (MOE) also stated that the shift in funds from 
fuel to food subsidies is dependent on the GOI changing its oil 
price budget assumption from $60 a barrel to $80 a barrel. 
According to our contacts at the Ministry of Finance, the change in 
assumption raises the total amount of funds allocated for fuel and 
electricity subsidies (before moving funds to the food sector) by Rp 
69.1 trillion ($7.6 billion) to Rp 144.7 trillion ($15.9 billion). 
The GOI currently estimates that the price of the entire food 
stabilization package (including food subsidies, lower import duties 
and higher export taxes) will be Rp 13-14 trillion ($1.4-$1.5 
billion). 
 
¶8. (SBU) The large cost of the program will put pressure on the 2008 
budget deficit, initially projected at 1.7% of GDP.  The cost of the 
food stabilization program alone, at Rp 13-14 trillion, will raise 
the deficit by 0.4% of GDP, regardless of where the government 
generates the funds.  At the same time, Indonesia's budget is under 
pressure from rising oil prices.  Changing the price assumption for 
fuel to $80 a barrel will increase the budget deficit by 1.8% of 
GDP.  The IMF calculates that every $10 increase per barrel in the 
price of oil, worsens the fiscal balance by 0.1% of GDP, but notes 
that the impact is not linear as fuel smuggling and other issues 
come into play as well.  Few analysts expect the actual global price 
of oil, currently close to $90 a barrel, to drop in the near term, 
suggesting the actual cost of energy subsidies may be even higher. 
(Note:  The GOI will partially fund the food subsidy program by 
diverting funds from energy subsidies, meaning the total impact of 
the food price package and raising the budget assumption will be 
less than the sum of their impact.  End note.) 
 
¶9. (SBU) The food stabilization program also has long-term 
implications for the budget and the economy.  The large fuel 
subsidies that the GOI removed in 2005 mainly affected wealthier car 
and motorcycle owners.  Food subsidies largely help the poor, making 
their removal politically difficult.  Although GOI has limited the 
soybean stabilization policy to six months, if the global soybean 
price remains firm beyond the six-month horizon, discarding the 
subsidy policy will likely entail a political cost. 
 
Longer-term Impact of Policies 
------------------------------ 
 
¶10. (SBU) Views on the effectiveness of the policy package are 
mixed.  Most analysts applaud the GOI plan to stimulate agriculture 
production and remove import duties, but believe the retention of 
export taxes on cooking oil will be ineffective.  Observers also 
note that the longer the food price subsidies are in place, the 
greater the costs.  If global prices continue to rise as expected, 
 
JAKARTA 00000286  003 OF 003 
 
 
the GOI must increase subsidies to keep pace.  The corresponding 
increase in the budget deficit could prompt a loss of confidence 
among investors and undermine Indonesia's hard won macroeconomic 
stability.  Food price subsidies can also lead to hording; the 
subsequent shortages can lead to significant unrest, undermining the 
initial objective of the policy. 
 
¶11. (SBU) Artificially lower food prices also reduce Indonesian 
farmers' incentive to increase production and lower the quality of 
food imports.  A local representative from Cargill recently observed 
that price ceilings would force his firm to export markedly lower 
quality beans to Indonesia.  The government has already announced 
lower standards on wheat imports.  The significant cost of the food 
subsidy program also makes large-scale investment in rural 
infrastructure much less likely, further clouding growth prospects 
for the agriculture sector and job growth in rural Indonesia. 
 
HEFFERN