Global Business Guide Indonesia

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Agriculture | Indonesia's Downstream Rubber Industry – Waiting for Investors

With global prices for natural rubber trading near five-year lows, Indonesia's push to develop the country's downstream industries takes on a new significance. Indonesia is the world's second largest producer of natural rubber, just slightly behind Thailand and far ahead of Vietnam and Malaysia. Together the four countries satisfy most of the global appetite for rubber. Falling to $1.50 USD per kilogramme in late 2014 (from more than $6 USD in 2012), the price for tire-grade rubber reached a level that is too low to cover the production costs of many Indonesian growers, especially smallholders. Earlier efforts by the main producer countries to lift prices by curbing output had proven ineffective.

Indonesia's Downstream Rubber Industry – Waiting for Investors
It is interesting to note that Indonesia has in place a progressive export tax regime to support downstream palm oil and cocoa businesses, while no equivalent exists for rubber.

For Indonesia, processing more of the commodity domestically rather than shipping it abroad in unprocessed form is a way to increase domestic demand and thereby alleviate the impact of low global prices, but building the processing and downstream industries requires substantial capital expenditure. Given the country's rising need for rubber, this is an opportunity investors should take a look at.

Overview of the industry

Sumatra accounts for around two-thirds of the rubber latex harvested in Indonesia, while Kalimantan, Sulawesi and Java also contribute to national output. The industry is dominated by smallholders, who work 85% of the 3.5 million hectares of land under cultivation and contribute 81% to national output. The remainder is split more or less equally between private and state-owned plantation companies. The limited investment capacity of smallholding farmers and the lack of scale as well as technological sophistication explain Indonesia's low productivity in rubber, with per-hectare yields significantly lower than in the other major producer countries.

National output reached 3.1 million tonnes in 2013, and the Indonesian Rubber Association (Gapkindo) expected a similar or slightly lower performance in 2014. The vast majority of produce is exported, with the domestic automotive sector consuming most of the remainder. The value of natural rubber exports tumbled from $11.77 billion USD in 2011 to $6.91 billion USD in 2013, according to Trade Ministry data, which reflects the dramatic fall in prices. Altogether, Indonesia exported $9.39 billion USD worth of rubber and rubber-made goods in 2013, amounting to 5.1% of the country's overall exports (6.3% when excluding oil and gas). The top export destinations in 2013 were the US, China and Japan.

Production and Exports of Natural Rubber (in million tonnes)

Production and Exports of Natural Rubber (in million tonnes)

Sources: Statistics Indonesia (BPS); Ministry of Agriculture; * 2014 figures: Estimates from Gapkindo

Adding value to natural resources

In recent years, the Indonesian government has been stressing the need to nurture downstream industries in both the agricultural and mining sector and has employed a carrot and stick approach to encourage investment. The idea is to add value to the country's major export commodities by building manufacturing industries around them. Thanks to rapidly rising demand from the domestic automotive and other industries, rubber could be one of the foremost beneficiaries of this policy. With around 85% of Indonesian rubber leaving the country, there is ample resource that could potentially support a thriving rubber goods industry.

Currently however, downstream activity in rubber is less than impressive and is limited both in scale and scope (chiefly tires and gloves) (See Indonesia’s Automotive Industry). According to Indonesia's Investment Coordinating Board (BKPM), most investment in the rubber industry from 2011 to 2013 went into upstream activities, such as rubber curing and the production of crumb rubber and smoked sheets. One of the main obstacles to building latex processing facilities and rubber goods factories is the lack of infrastructure in remote regions, especially reliable access to gas and electricity (See Electrifying Indonesia – Opportunities for Independent Power Producers). Another difficulty is that the natural rubber industry needs to grow hand in hand with chemical industries (including synthetic rubber) to produce the compounds used in end products.

Unlike rubber, other major Indonesian plantation crops have seen active development downstream, with the capacity for crude palm oil refining and cocoa grinding growing rapidly over the past few years (See Indonesia's Booming Cocoa Industry Puts Farmers to the Test and An Overview of Indonesia’s Palm Oil Industry). It is interesting to note that Indonesia has in place a progressive export tax regime to support downstream palm oil and cocoa businesses (in accordance with Ministry of Finance Regulation Number 67 of 2010), while no equivalent exists for rubber. In this regime, the tariff on unprocessed shipments increases as global prices for the commodity exceed certain  thresholds and drops when benchmark prices fall, thereby helping to secure sufficient supplies for processing and manufacturing industries. It is conceivable that a similar measure may be introduced to support rubber processing and the manufacture of rubber-based goods.

Meanwhile, a 10% value-added tax (VAT) imposed on numerous commodities, including rubber latex, in July 2014 was heavily criticized in the industry, with producers warning it would hurt rubber output and exports.

Rubber industry clusters

As an incentive to spur development of specific regions and industries deemed important for the country's overall economic development, Indonesia grants a multifaceted tax facility on certain investment projects (based on Government Regulation Number 1 of 2007). The list of eligible activities was extended several times and includes downstream rubber industries. Investors can apply for a reduction of corporate net income tax amounting to 30% of the investment value (spread out over six years) and reduced income tax on dividends paid to offshore taxpayers. In addition, the same projects may qualify for accelerated depreciation and amortization and more generous carry-forward of losses. The combined effect of the facility is to reduce the tax burden in the early stages of a project.

More important than these financial incentives, at least in the long run, is the government's industrial policy. Indonesia's development master plan (MP3EI) foresees the establishment of regional growth centres for different industries (See Indonesia's Economic Potential: A Look Beyond Java). Sumatra is set to become the focal point for the natural resource industry in general and the rubber products industry in particular. The stated goal is to provide simple procedures, swift permits and reliable infrastructure for manufacturers looking to set up shop in designated industry clusters, with a view to facilitating the growth of vertically and horizontally integrated agro-industrial centres. Ultimately, this should boost the range and quality of local rubber-made products, such as conveyor belts and other industrial goods as well as tires and spare parts for the automotive industry.

While Indonesia's rubber industry clusters at present exist mainly on the drawing board, the policy as such has its merits, because the long-term outlook for the downstream rubber industry is positive. Blessed with the climatic conditions and space for rubber plantations and suitably located in a quickly-developing and motorizing region of the world, Indonesia offers investors access to both the resource and the market for rubber products. Assuming regulations do not get in the way, this combination should eventually bring forth a prospering integrated rubber industry.

Global Business Guide Indonesia - 2015

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Indonesia Agriculture Snapshot

Contribution to GDP: 13.70% (2016 including Fisheries & Livestock)
Number Employed in the Sector: 46 million (2016)
Main Products: Palm Oil, Palm Kernel, Rubber, Cocoa, Coffee, Tea, Tobacco, Rice, Sugarcane, Maize, Cassava, Tropical Fruits, Spices, Poultry, Fisheries.
Main Export Markets: China, USA, Japan, India, Singapore, Malaysia, Pakistan, South Korea, Italy, Netherlands, Bangladesh, Egypt.
Relevant Law: Presidential Regulation No. 39 of 2014 on the Negative Investment List imposes varying degrees of foreign ownership limitations in plantations depending on the crop type, and Government Regulation No. 98 of 2013 limits private plantations to 100,000 hectares.