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«adb economics no. 411 working paper series october 2014 ASIAN DEVELOPMENT BANK   ADB Economics Working Paper Series Industrial Policy in Indonesia: ...»

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Promoting greater domestic value adding will increase the sector’s income earning potential, and consequently, revenue potential. Taking the example of nickel, Indonesia exported 55 million tons of nickel ore at around $35 per ton. This amount of nickel ore can be converted to half a million ton of nickel at $18,000 per ton. The potential difference in the value of exports would be $7.1 billion (Soelarno 2014). How this would be translated into economic returns, however, would depend on the costs of developing and operating the downstream nickel industry in Indonesia.

The short-term impact of the ban will be the upward impact on the world price of commodities, particularly for minerals, for which Indonesia is a major global supplier. Buyers that rely heavily on Indonesian ores would be among the worst affected. The PRC, for example, imported 70.0% of its bauxite from Indonesia (Sulistio 2014). At the same time, opponents to the ore export ban also point to the likely worsening of the country’s trade balance due to the decline in ore exports. In one estimate, trade deficit will increase by $5.0 billion to $17.7 billion or from 1.1% to 1.7% of GDP (Sulistio 2014).

This view is incomplete, however, as it does not take into account of the longer-term impact of the ban, which, assuming competitive downstream industries could be developed, would lead to an increase in processed mineral exports that would more than offset the initial loss.

Experts have also argued that due to the high capital requirement in setting up smelters, Indonesia cannot afford to further postpone the implementation of the ban, as the economic


See http://www.esdm.go.id/ministry-of-energy-and-mineral-resources/vision-and-mission.html 34 | ADB Economics Working Paper Series No. 411 feasibility of such investment would be reduced if the country’s ore reserves have been significantly absorbed by global demand.

C. From Policy to Implementation Efforts to meet above policy objectives have been intensified in the last 5 years, starting with the introduction of Law No. 4 on Mineral and Coal Mining in 2009. The law obliges mining licence holders and production sharing contractors to process and purify mineral ores domestically, in which export of ores was banned starting 12 January 2014. For a few years, the law did not catch people’s attention, partly because of the delays in the introduction of regulations to implement it and partly because business expects the GOI to make last minute changes as the law was unlikely to proceed without opposition from the powerful industry lobby.

The inertia on the business part has not only created uncertainties to investors, but also left the industry unprepared for the 12 January 2014 deadline. Ministerial regulations on the technical details of the domestic processing of mineral ores were issued only in May 2012, giving only less than two years before the deadline. Building smelters is a big investment that requires significant infrastructural support, including electricity. Smelters would have to be built outside of Java, close to the source of materials, but where the condition of infrastructure remains wanting. This is not a problem that can be left to the private sector alone, as the investment for captive power unit is sometimes larger than the investment for the smelter itself (Lingga 2014). The regulation, among other things, also imposes an average of 20.0% export taxes on 65 types of raw materials, excluding coal, and the rate was expected to increase to 50.0% the following year, leading to a complete ban in 2014 barring some exemptions (Tijaja 2013a). The regulation also laid out the required purity level for each individual mineral (McBeth 2014) As the deadline was looming, Susilo Bambang Yudyohono’s (SBY) administration realized that the implementation of the law would face a high probability of failure, and submitted a request for a 3year extension to the introduction of the ore export ban to buy more time for the industry to build smelters. This appears to be a time-buying strategy with no obvious plans on how to address underlying issues. On 5 December 2013, the Energy Commission decided to refuse the SBY’s administration request. Skeptics were quick to point that the refusal was a reflection of pre-election populist campaign than a genuine reflection of policy consistency.

In anticipation of the export ban, businesses hiked up exports in the months preceding the ban.

Major importers have also expressed their concerns, and Japan had signalled the possibility of taking the case to the WTO. The 2009 Mining Law also requires foreign majority-owned firms to divest majority ownership to national investors 10 years after commercial production.

As it was becoming obvious that the implementation of the ore export ban will be going ahead as scheduled, the GOI devised an 11th hour strategy to ensure implementation. It was obvious that the permitted mineral purity level set in the 2012 ministerial regulation is unlikely to be achieved under the current domestic smelting capacity. The responsible ministry, KESDM, issued Regulation No. 1 of 2014 in January setting out a revised purity level. The regulation maintains the obligation for the processing of five main mineral commodities of nickel, bauxite, lead, gold, silver, and chromium (to 99.9% purity level) because there are no semi-processed products. However, copper, lead, iron, zinc, and manganese can still be exported in concentrate forms up to 3 years. The watered down new allowable levels of purity were 15.0% for copper, 57.0% for lead, 62.0% for iron, 52.0% for zinc, 49.0% for manganese, and 56.0% for ilmenite (titanium).

Industrial Policy in Indonesia: A Global Value Chain Perspective | 35 The decision on the new minimum purity levels led to protests by some as the new levels were seen to favor US-based giant mining companies PT Freeport Indonesia and PT Newmont, which together hold a dominant share of 97.0% of the country’s total copper output. Both companies have already passed the minimum level (15.0% for copper concentrates) with their current processing level of around 22.0% for Newmont and 27.0% to 30.0% for Freeport (Jakarta Post 2014a; Pattiradjawane 2014).

A new twist to the story came soon with the imposition of progressive export tax obligations by the Ministry of Finance on mineral concentrate exports. Progressive export taxes started with 20.0% (25.0% for copper) in the first year until 31 December 2014, rising in half yearly increments to a prohibitive 60.0% in the second half of 2016. All minerals are to be refined in domestic smelters by 1 January 2017. The relief of PT Freeport Indonesia and PT Newmont from being allowed to export copper concentrates for another 3 years was short-lived. Both saw the imposition of progressive export taxes as a violation of their contracts, which prescribe no new taxes. Legal opinion, however, highlighted that the claimed violation might not be valid as the new taxes are being applied indiscriminately to all firms, not just to Freeport and Newmont, and are part of Indonesia’s legal framework, which the contracts would need to adhere to. Informed analysis would require assessment of the actual contract terms.

Firms that do not have the capacity to build their own smelters would have to cooperate with others that do. Many foreign-based mining firms insisted that building smelters were commercially unfeasible, with some threatening closures or layoffs if implementation of the law is to go ahead.

However, there is variation in private sector response, as shown later.

In addition to the obligation to pay progressive export taxes, exporters of processed minerals like copper iron or manganese concentrates, are also required to obtain export permit, but not those exporting refined minerals, such as nickel matte and ferro nickel (Yulisman 2014a). All mineral exporters, however, have to be registered exporters at the Ministry of Trade and undergo pre-shipment verification. The export permit is required to acknowledge that exporters have met the minimum processing level set by the KESDM, with a recommendation on their volumes and types of products from the said ministry. The GOI also requires firms that have committed to building smelters to deposit some funds as a guarantee of their commitment. The fund will be deposited into a bank and monitored by the KESDM. The amount of guarantee has yet to be set, but is estimated to be around 5.0%–10.0% of project value.

Whether the industry will be able to build sufficient domestic smelting capacity in time for the 2017 deadline remains to be seen. But failure to implement this obligation will adversely affect the credibility of the GOI’s policy. Currently, out of a total of 4,458 mining permit holders, only 66 are committed to building smelters, with 12 others currently conducting feasibility studies to build smelters. Of the 66, 25 are in the final stage of constructing their smelters, 10 are in the middle of construction, 15 have just started, and 16 are still awaiting government approval of their environmental impact analysis (Jakarta Post 2014a).

Some mining companies still think twice about developing smelters for various reasons, including economic infeasibility. The Indonesian Employer Association (APINDO) is concerned that the development of smelting facilities may not be effective to increase export earnings considering many countries have developed a mineral processing industry and this may result in an oversupply of processed minerals in the international market. On the other hand, Indonesia, as one of the world’s 36 | ADB Economics Working Paper Series No. 411 largest mineral ore exporters, already had established markets and trading partners for these commodities. APINDO suggests that even if giant mining firms, such as PT Freeport Indonesia and Newmont, were able to develop new smelting facilities as required by the new policy, they are not sure whether the products can be marketable enough in the international market given the abundance of these processed products, and the fact that overseas buyers for these products are yet to be identified.

APINDO suggests that the government should allow some flexibility in the implementation of the 2009 Mining Law. 29 The strong response from the private sector has led to yet another backtracking on the part of the GOI. The GOI is revising the progressive export tax and is currently drafting a new regulation on export duties that would more than halve the base rate to be paid by miners (Reuters 2014). The current export tax kicks in at 20.0% to 25.0% and rises to 60.0% in the second half of 2016, before a total concentrate export ban in 2017. The new reduced export taxes will be available only to eligible mining companies that have agreed to build a smelter in the country. Additionally, the policy would also include tax incentives for the construction of smelters within the country (Dezan Shira & Associates 2014).

While the most audible response from the private sector has been the reaction from mining giants, such as Freeport and Newmont, reactions actually vary even among the private sector. PT Freeport Indonesia started off as one of the more aggressive firms in opposing the policy. It has been threatening arbitration, output cuts or suspension, and layoffs (Jensen 2013). A subsidiary of USbased Freeport McMoran Copper and Gold is currently working to get its export licence to enable it to continue exporting copper concentrates (Cahyafitri 2014a). Freeport produced 915 million pounds of copper in 2013 and is currently supplying 40.0% of its annual sales to PT Smelting in Gresik, East Java, which has been operating since 1999, valued at $1.7 billion in 2013, 400 million less than in 2012. In a positive development in July 2014, the GOI announced that it has successfully reached an agreement with the firm in a form of a memorandum of understanding (MoU), which would help smooth the path for the firm’s contract renegotiation with the new government. Contract renegotiation is mandated by the new law and will center on six issues: the company’s value-added obligation, contractual period, size of operation, local content obligation, government revenue and divestment. In the MoU, Freeport Indonesia has agreed to reduce its operation size, increase royalty payments, and pay export taxes in accordance with the progress of the construction of its smelter. It has also been given the permission to resume exporting its copper concentrate as soon as the Finance Ministry completes revising its regulations on export duties.

Newmont initially appeared to be taking a more conciliatory approach by seeking ways to find a solution together with the GOI. However, it then took a hard stance by first suspending its operations at its Batu Hijau mines, following the halt in the production and processing of copper concentrate. Its copper concentrate storage facilities have reached full capacity as it was unable to export without paying export taxes (Forbes 2014). Like other firms, Newmont insisted that the GOI export restriction policies violate the agreed contract. In July 2014, Newmont decided to lodge an appeal to international arbitration against the GOI. In response, the GOI expressed its disappointment with Newmont’s appeal, as it was done in the course of negotiations to look at the possibility of jointly building a smelter with Freeport and the majority GOI-owned PT Aneka Tambang (PT ANTAM), and asked Newmont to withdraw this or face ramifications (Cahyafitri 2014b). Following further negotiations, Newmont agreed to withdraw the arbitration case after reaching an agreement with the GOI on outstanding


Interview with Sofjan Wanandi, Chairman of the Indonesian Employer Association (APINDO) on 8 April 2014.

Industrial Policy in Indonesia: A Global Value Chain Perspective | 37 issues, such as export taxes and royalties, which will enable them to resume exporting copper concentrate (Sudrajat and Otto 2014).

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