VZCZCXRO1474
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #0780/01 1090724
ZNR UUUUU ZZH
R 180724Z APR 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 8736
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 1846
RUEHBJ/AMEMBASSY BEIJING 4960
RUEHBY/AMEMBASSY CANBERRA 2359
RUEHUL/AMEMBASSY SEOUL 4539
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 04 JAKARTA 000780 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA-SETH SEARLS 
COMMERCE FOR 4430/KELLY 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN 
DEPARTMENT PASS EXIM BANK 
SINGAPORE FOR SBAKER 
TOKYO FOR MGREWE 
USDA/FAS/OA YOST, MILLER, JACKSON 
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER 
USDA/FAS/OGA CHAUDRY, DWYER 
USTR WEISEL, EHLERS 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON EAGR ID
SUBJECT: INDONESIA: FOOD PRICES DIM ECONOMIC PROSPECTS 
 
 
A) Jakarta 762 B) Jakarta 684 C) Jakarta 286 
 
¶1. (SBU) Summary.  Economists continue to lower their projected 2008 
growth rate for Indonesia due to concerns that inflation and global 
uncertainty will decrease economic performance more seriously than 
previous expected.  Soaring food prices, which have lowered 
purchasing power among Indonesian households, threaten to drive down 
domestic demand.  The price of rice, which represents the largest 
share of the food budget, could rise significantly this year. 
International rice prices are now close to $700 per metric ton (MT) 
higher than the price in Indonesia.  External demand for Indonesia's 
manufactured goods is expected to slow this year as world growth 
decelerates, limiting the scope for new job creation.  While few 
analysts predict a full-blown economic crisis, the economic and 
social policy focus has become increasingly short-term, diminishing 
Indonesia's medium-term growth potential.  Investors are also 
increasingly concerned about fiscal sustainability and macroeconomic 
management in Indonesia, highlighting the importance of policy 
decisions in the coming months.  End Summary. 
 
Food Prices Continue to Soar 
---------------------------- 
¶2. (SBU) Inflation continues to accelerate in Indonesia due in large 
part to rapidly rising food prices.  Table 1 illustrates the 
magnitude of the problem in Indonesia.  The retail price of flour 
and soybeans have risen 70% and 44%, respectively, in the past 12 
months.  The price of cooking oil and instant noodles are up roughly 
30% in the past year.  High prices for these Indonesian staple foods 
are likely to persist given that poor harvests, growing demand from 
emerging markets, and increased use of food to produce alternative 
sources of energy continue to push up international prices.  The 
high price of soybean meal, which farmers use as poultry feed, has 
also helped drive up the price of chicken and eggs, a key source of 
protein in Indonesia, by roughly 30% over the past year.  The rise 
in food prices has already translated into higher overall inflation 
in Indonesia.  The CPI inflation rate jumped to 8.2% (YoY) in March, 
well outside the central bank's 4-6% percent target range.  Some 
analysts predict the rate could rise as high as 10% before the end 
of the year. 
 
Table 1:  Food Price Increases as of February 2008 
--------------------------------------------- ----- 
        Year-on-Year Change 
 
Rice*      -4.1% 
 
Flour      69.1% 
 
Soybeans      43.7% 
 
Palm oil      29.2% 
 
Instant Noodles    29.5% 
 
Poultry      32.9% 
 
Eggs       34.5% 
 
--------------------------------------------- -------- 
Source:  Foreign Agriculture Service Survey 
*Note:  Rice prices rose significantly in 2006 
--------------------------------------------- -------- 
 
Rice Presents Biggest Risk 
-------------------------- 
¶3. (SBU) The rise in food prices has not yet incited widespread 
protests from the poor or significantly reduced domestic 
consumption, but that may change if rice prices begin to rise.  Rice 
accounts for roughly one-third of poor household spending.  With 
roughly 50% of Indonesia's population at or near the poverty line, a 
rise in the price of rice could substantially reduce the standard of 
living of over 100 million Indonesians.  The World Bank estimates 
 
JAKARTA 00000780  002 OF 004 
 
 
that every 10% rise in the price of rice puts an additional 2 
million people below the poverty line (income of $1.55 a day or 
less).  In contrast to the international price, the cost of rice has 
declined in Indonesia over the past year, as rice prices were 
already high relative to international prices in 2007.  But the 
international price is now $700 per metric ton (MT) higher than the 
price in Indonesia, creating a significant incentive to smuggle rice 
out of the country and raising the risk that prices will climb again 
rapidly this year. 
 
¶4. (SBU) High rice and other food prices are expected to hit hardest 
in Java, where income and job growth remain limited.  According to 
executives at Indofoods, sales of wheat base products fell most 
dramatically in Central Java when the price of wheat began to rise, 
providing support for the view that purchasing power is lowest in 
that area.  Java is also likely to be the source of most rice 
smuggling efforts as roads and transportation links there are 
superior to most other parts of the country, making it easier for 
illegal traders to move goods.  According to discussions with local 
traders, inter-island trade is up substantially this month, from 
around 200-250 MT/month to around 500-600 MT month.  Traders note 
that the increase in activity reflects pre-positioning in rice 
deficit regions in anticipation of local price increases.  However, 
experts also worry this could be an early sign of smuggling. 
 
¶5. (SBU) Indonesia's ability to thwart rice price increases is 
limited by several internal and external factors.  First, pressures 
on global prices are unlikely to abate and are outside of GOI 
control.  Experts estimate that there is currently a 4 million MT 
shortfall in rice stock available to the international market, which 
will push rice prices significantly higher throughout the year. 
(Reftel A)  The shortfall is mainly the consequence of export 
restrictions in India and Vietnam that are unlikely to be removed in 
the near term. Strong demand from rapidly growing developing 
countries is also a factor.  Second, the GOI has failed to 
meaningfully invest in the agriculture sector over the past decade, 
resulting in deterioration in agriculture productivity.  Experts 
note that Indonesia's fertilizer and seed technology is 30-40 years 
old, while irrigation systems continue to age without funds for 
repair.  Third, Indonesia's fuel and electricity subsidy scheme 
limits the amount of money available to invest in agriculture 
infrastructure or provide shorter term assistance to the poor.  If 
oil prices remain near $100 per barrel, Indonesian could spend as 
much as $25 billion (roughly 25 percent of the budget) on subsidies 
this year. 
 
GOI Focuses on Short-term Solutions 
----------------------------------- 
 
¶6. (SBU) The GOI plans to combat rising food prices with short-term 
policy measures, such as temporary trade liberalization, export 
taxes, subsidies and cash transfers to the poor, which are costly 
and fail to address underlying weaknesses in the sector, according 
to government advisors.  The GOI already removed import taxes on 
soybeans and wheat, increased export taxes on palm oil, and 
developed rice subsides for the poorest of the poor (Refs B and C). 
Yet international prices continue to rise, countering the 
effectiveness of these policies. 
 
¶7. (SBU) World Bank officials who are working closely with the GOI 
on the issue of food prices and poverty say that the government is 
considering an additional cash transfer program to directly increase 
the purchasing poor of the poor.  Yet the price of such a program is 
likely to be significant.  There are roughly 19 million households 
on the government's list of poor families, according to the World 
Bank.  Therefore, a Rupiah 50,000 ($5.50) per month per family cash 
transfer would cost the government Rupiah 11.4 trillion ($1.3 
billion) this year.  While this is likely to be an effective 
short-term measure, the cash transfer program fails to provide a 
long-term solution to poor productivity in the agriculture sector 
and slow job growth, which keep Indonesia extremely vulnerable to 
food and other price shocks. 
 
JAKARTA 00000780  003 OF 004 
 
 
 
Investment and Domestic Demand to Slow 
-------------------------------------- 
¶8. (SBU) The GOI's 2008 GDP growth projection of 6.4% is now well 
above most market forecasts, due to disparate views between the GOI 
and analysts on domestic demand and investment rates.  The 
government projection is based a continuation of current domestic 
demand and investment trends, and only a modest decline in net 
exports.  However, market analysts note that soaring food prices and 
low job growth have reduced consumer confidence, which is now at a 
two year low.  If inflation rates remain high, Bank Indonesia (BI) 
will also need to raise interest rates, which could significantly 
slow consumer finance and investment. 
 
¶9.  (SBU) On the external side, most analysts expect Indonesian 
exports to continue to benefit from high commodity prices, but 
predict Indonesian manufacturing exports will decline this year in 
response to flagging demand in Japan and the United States.  Some 
GOI advisors have also stated that BI plans to actively maintain or 
increase the value of the Rupiah in an effort to limit imported 
inflation, a move that could hurt Indonesian exporters.  The cost of 
imported food and commodity-based finished products are also likely 
to lift the import bill this year, potentially reducing the trade 
balance. 
 
¶10. (SBU) The expected slowdown in manufacturing exports will also 
disproportionately impact jobs, potentially increasing the number 
people vulnerable to poverty.  Every $1 billion in manufacturing 
exports creates 242,000 jobs, whereas the same amount of exports of 
coal, mining, or chemical products create only 12,000, 43,000, and 
8,000 jobs, respectively, according to research study by Chatib 
Basri of University of Indonesia and Gustav Papanek of Boston 
University.  The same study notes there have been no new jobs 
produced among large and medium firms in Indonesian in the last ten 
years because of stagnant growth in job-creating export sectors such 
as manufacturing.  Yet 20 million people have joined the workforce 
since 1997.  Most of these people are currently underemployed in the 
agriculture sector, living on very low wages and remaining extremely 
susceptible to poverty, according to Basri and Papanek. 
 
No Crisis Yet, But Outlook Dims 
------------------------------- 
¶11. (SBU) The current economic team is likely to avoid serious 
economic policy missteps, but risks to growth and macroeconomic 
stability are rising.  Incoming BI Governor Boediono, Finance 
Minister Sri Mulyani Indrawati and Trade Minister Mari Pangestu have 
a strong track record for maintaining macroeconomic stability and 
are unlikely to allow GOI spending or inflation to expand unchecked. 
 Indonesia's banking sector remains sound and BI has accumulated $57 
billion in foreign exchange reserves, equivalent to 9 months of 
imports.  Nevertheless, Indonesia faces a number of external risks 
beyond the control of policymakers and political pressure for 
short-term policy fixes are expected to increase in advance of the 
2009 election. 
 
¶12. (SBU) Analysts note that investors are increasingly worried 
about the ability of the GOI to control the budget in light of 
rising food and oil prices, underscoring the importance of prudent 
policy making in the current environment.  Introducing a large cash 
transfer program without a reduction in fuel subsidies is likely to 
increase their concern.  Markets have already declined sharply in 
April in response to worries that the fuel subsidy regime presents 
an unlimited liability to the government.  The Indonesia Stock 
Exchange index fell 7.1% within the first week of April and the 
yield on 5-year Indonesian Rupiah government bonds rose to 11.6% 
from 10.4% over that same period, according to a recent Standard 
Chartered Report. 
 
¶13. (SBU) If capital outflows accelerate, the Rupiah could come 
under pressure, adding fuel to the inflation fire.  A recent report 
from HSBC cites Indonesia (along with Vietnam) as the most "behind 
the curve" in terms of fighting inflation, due to monetary policy 
 
JAKARTA 00000780  004 OF 004 
 
 
loosening in 2007.  Six months ago financial analysts expected the 
Indonesian economic growth to run close to 7.0% in 2008, on higher 
investment, domestic consumption, and strong exports.  Analysts now 
worry that the need to aggressively fight inflation and slowing 
world demand will push Indonesia's growth rate below 6.0%, with 
limited potential for new job creation or poverty alleviation. 
 
HUME