Impact Evaluation Study on the Bank Operations in the Industrial Crops and Agro-Industry Sector in...

8/3/2019 Impact Evaluation Study on the Bank Operations in the Industrial Crops and Agro-Industry Sector in Indonesia

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ASIAN DEVELOPMENT BANK IES:INO 97010

IMPACT EVALUATION STUDY

OF

BANK OPERATIONS IN THE

INDUSTRIAL CROPS AND AGRO-INDUSTRY SECTOR

IN

INDONESIA

August 1997


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CURRENCY EQUIVALENTS

Currency Unit - Rupiah (Rp)

Rp1.00 = US$.000425US$1.00 = Rp2,350.00

ABBREVIATIONS

DGE - Directorate General of EstatesEIRR - Economic Internal Rate of Return

FFB - Fresh Fruit BunchesGDP - Gross Domestic ProductIES - Impact Evaluation StudyIPM - Integrated Pest ManagementNES - Nucleus Estate and SmallholdersPCR - Project Completion ReportPMU - Project Management UnitPPAR - Project Performance Audit ReportPTP - Perseroan Terbatas Perkebunan (Government-owned Corporation)SSTA - Small-scale Technical AssistanceTA - Technical Assistance

NOTES

(i) The fiscal year (FY) of the Government ends on 31 December.(ii) In this Report, "$" refers to US dollars.

IE - 43


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EXECUTIVE SUMMARY

The industrial crops comprise the tree crops subgroup namely oil palm, rubber,coffee, cocoa, tea, and cashew nut; and crops such as sugar, cotton, and other fiber crops.Together, the industrial crops occupy 40 percent of the cultivated land, account for more than 17percent of the agricultural gross domestic product, provide employment for 30 percent of thelabor force, and contribute to the countrys non-oil foreign exchange earnings.

As of June 1997, the Bank had approved 18 loans totaling $683 million for 17projects, and 26 technical assistance (TA) operations amounting to $8.6 million for the agro-industry and industrial crops sector. Most of this has supported tree crops. The Banks loanscomprise about one third of the external assistance, and about 5 percent of the total investmentfor the tree crops subsector. Eleven of the Bank-assisted projects have been completed and fiveof these postevaluated. Of the five postevaluated projects, three were generally successful, and

two partly successful.

The Banks assistance has followed the Governments development directionsand strategies. Thus, the first five projects, implemented from 1970 to 1981, aimed primarily toexpand and rehabilitate public sector plantations and processing facilities. The key goals forthese earlier projects were increases in non-oil exports and public sector foreign exchangeearnings. Although smallholders were involved in some of the earlier projects, it was not untilafter 1980 that smallholder development became a primary focus. All of the six completedprojects initiated between 1981 and 1988 were directed wholly or partly towards improvingsmallholder incomes. Five of these projects were based on the nucleus estate and smallholders

(NES) development model where smallholders are settled onto crop land established for themsurrounding a central estate and processing facility. In addition to improving conditions forsmallholders, improvements in food security, export diversification and foreign exchangeearnings, and an improved regional balance of development were important goals at the time.Since 1989, the Governments development approach for foreign-assisted projects has focusedon the use of the project management unit (PMU) approach whereby existing smallholders areassisted to improve production and processing through extension and credit support providedunder the projects. All of this group of projects are ongoing.

Seven of the eleven completed Bank-funded projects focused on oil palm and

form a significant, relevant, and generally successful development effort. The projects weresupported by Bank TA geared towards deregulation of the oil palm industry. Each project ismeeting its area target, and the crop yields and factory productivity are satisfactory andsustainable. These projects are economically viable as indicated by their recomputed economicinternal rates of return of 10 to 20 percent. Although their institutional impact is modest, theprojects are having a positive impact on farm incomes and poverty reduction, foreign exchangeearnings, food self-sufficiency, and economic growth. Their negative impact on the physicalenvironment is minor. The success of the projects, coupled with the industry deregulation as a


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result of the Bank TA, have stimulated additional private investment in parts of Sumatra, wherethe Bank-funded oil-palm projects are concentrated.

The success achieved with oil palm has been largely due to the crops

competitive advantages. The yields have been consistently good and the prices for palm oil,expressed in local currency, have been consistently attractive. However, the scale of thecombined projects for oil palm, their concentration in specific locations and with the sameimplementing agency, the sequential approach to development which built upon strengthsestablished under earlier projects and the complementary TAs, constitute a sound long-termdevelopment program. Important criticisms of the program, however, are the high public costper beneficiary of the NES approach and the focus on new land development as opposed to theimprovement of existing farmland.

The successes with oil palm were not repeated in the two completed Bank

projects involving cotton and cocoa/coconut that experienced underachievement of theprojected area and yield targets, and negative economic internal rates of return. The cocoa cropalso has been infested with pod borer which affects sustainability of the small gains alreadyachieved. Both these projects were developed using the NES approach, but the conditions forsuccess inherent in the oil palm projects were lacking. Overall, neither the smallholders nor thenucleus estate developers have benefited greatly from the cocoa/coconut and cotton projects.Moreover, investments in these projects appeared ad-hoc in nature, not forming part of anylong-term development program for either the areas or crops involved. The two other completedBank projects within the sector involved sugar and fiber crops but were not reviewed under thisstudy.

The Banks ongoing projects in the tree crops subsector have attempted tospread development over as wide an area as possible by adopting the PMU approach whichhas a low cost per beneficiary compared with the earlier NES schemes. The initial experiencefrom these ongoing projects suggests that the expected output targets may not be fully achievedas smallholders do not use high input, high output production systems. Further, the prevailingmarket system does not encourage efforts to improve product quality. Consequently, some ofthe appraisal assumptions regarding beneficiary participation, the effectiveness of extensionservices to cause change in production systems, and projected yields appear overoptimistic atthis stage. In addition, the main crops supported under the PMU projects are rubber, cashew,and tea that have lower potential than oil palm for raising farm incomes. The replanting programwhere trees of low productivity are replaced by higher yielding varieties is expected to give the

best results. However, there are indications of variable quality in tree establishment andmaintenance. There also are doubts that the developments will be adequately supported at theend of the project implementation period. After project completion, the provincial staff must takeover the smallholder support functions using their regular budget which is less than thatprovided to the PMUs.


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The Banks experience within the sector to date highlights the value of selectingprojects that form part of a long-term plan for an area, crop, or community. Advisory andoperational TA can provide important support for such long-term development programs. Wherelong-term planning is weak, the requirement under the Banks loans to finance all relatedaspects within a 5-6 year time frame can contribute to the setting of overambitious developmenttargets.

Although the NES approach to development entails high cost, the abrupt andcomplete change from NES to PMU approach which occurred in the late 1980s needs to becarefully reexamined because the NES approach has proven to be successful for oil palm.Rather than being totally rejected, the NES development approach should be further refined,such as by using it only where conditions are favorable, and limiting the area developed perbeneficiary under a project so as to reduce the per beneficiary cost. More private sectorparticipation in establishing NES projects, could also be encouraged. Since the PMU approachalso appears to be producing mixed results, its review and improvement are also appropriate.

The experience to date shows that a successful outcome under the NESapproach requires (i) strong profitability of the core productive unit or crop; (ii) adequatecapacity and capability of the nucleus estate and/or mill operator to implement and operate thescheme; and (iii) a strong interdependence, for example, through product processing, betweenthe nucleus estate (and/or mill operator) and the smallholders to facilitate credit recovery.

The sector experience also indicates that smallholders do not generally adopthigh input, high output production systems. Even in the NES oil palm projects which provide a

relatively assured and high income, the smallholder producers use lower than recommendedamounts of fertilizer and adopt relatively low management standards. Future project preparationand appraisal studies should address this issue in the design of specific components and/orshould use conservative assumptions about farmer responses and the yields that are to beexpected. This will help avoid problems arising from smallholders viability to repay the loansunder credit packages. In addition to the use of conservative yield assumptions duringappraisal, appropriate risk analysis is needed. There also do not appear to be any significantand widespread price incentives for higher quality for industrial crops such as cocoa and rubber.Given this situation, efforts to improve smallholder incomes through improvements in the qualityof crop outputs will be difficult.

The experience also suggests that project performance targets need to bedefined in terms of the development objectives, rather than simply in terms of physicalachievements. Achievement of the latter may not necessarily lead to the project objectives. Thepreparation of a project framework during project identification and subsequent refinementduring project preparation and appraisal would help in this regard. The application of this toolshould enable flexible and speedy responses to changes during project implementation, whileensuring that project inputs and outputs remain consistent with goals and beneficiary absorptivecapacities.


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The review of the Banks assistance has indicated areas where the Bank mayimprove its support to the sector, including strengthening the Governments medium to long-term planning capability and overcoming weaknesses in the NES and PMU approaches. Thereview has also identified scope for improving the completed oil palm projects, including the

need to address the balance between crop production and processing capacity, correction ofmanagement deficiencies in the mills, and improvement of fertilizer use. The spread of thedebilitating cocoa pod borer to one of the project areas also raises concerns about the need tostrengthen interprovince quarantine which may be addressed under the Banks ongoingIntegrated Pest Management for Smallholder Crops Project (Loan No. 1469-INO). However,effective quarantine may only be practical for some of the more isolated provinces, e.g., IrianJaya.


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I. INTRODUCTION

1. The industrial crops, and the agro-industries concerned with the processing ofthese crops, are an important part of Indonesian agriculture. Oil palm, rubber, coconut; thebeverage crops of coffee, cocoa, and tea; sugar, cotton, and other fiber crops, such as kenaf;and cashew nut are the main industrial crops. Together, they occupy 40 percent of thecultivated land, account for more than 17 percent of the agricultural gross domestic product, andprovide employment for 30 percent of the labor force. Rubber, oil palm, coconut, coffee, andcocoa contribute about half of all agricultural exports, equivalent to about 18 percent of all non-oil exports. Understandably, in its various development plans, the Government has givenimportance to industrial crops.

2. The Banks first involvement in the industrial crops and agro-industry sector inIndonesia was in 1969. As of June 1997, the Bank had approved 18 loans totaling $683 millionfor 17 projects, and 26 technical assistance (TA) operations amounting to $8.6 million (seeAppendix 1).1 Eleven of the Bank-assisted projects have been completed and five of thesepostevaluated.2 Of the five postevaluated projects, three were generally successful and two,partly successful.

3. This Impact Evaluation Study (IES) aims to assess the broad impact of theBanks operations on the sectors performance, draw out common lessons from the experience,and provide recommendations that may help improve future operations. The impacts of mostconcern are those on the socioeconomic conditions of smallholder beneficiaries, the financial

and institutional capability of the entities involved in the projects, the national economy, and theenvironment.

4. The main changes and impacts brought about by projects become evident onlyafter completion of project implementation and the harvesting of the crops has started. Hence,the study material has been drawn predominantly from the Banks 11 completed projects. These11 projects do not cover all aspects of the industrial crops and agro-industry sector, but havebeen primarily concerned with oil palm and the nucleus estate and smallholders (NES)3development approach. Consequently, the IES focuses mainly on these aspects of the sector.In addition, for purposes of providing broad benchmark information and a framework for

assessment, the study has limited its attention to the tree crops subsector. The tree cropssubsector is a commonly adopted grouping for which broad data is available, and it includes oilpalm, rubber, coconut, and cocoa for which the Bank has provided most support under itscompleted and ongoing projects.

1 A number of general agricultural projects, for example, area development projects, have also provided some support forthe industrial crops, but are not included in this group.

2 One of these five postevaluated projects was reevaluated in August 1989 (IE-10:A Reevaluation Study of the GohorLama Palm Oil Processing Project in Indonesia).

3 The NES approach is described in para. 10.


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5. The reviews of individual projects for this IES were conducted under a Small-scale Technical Assistance (SSTA)4 implemented during September to October 1996 (seeAppendix 2). The SSTA reviewed a small number of similar projects funded by the World Bankand the private sector for purposes of comparison. The results of the SSTA were supplemented

by an Impact Evaluation Mission to Indonesia in October 1996 which discussed sectorperformance with staff of the Government agencies, the public estate companies and privatesector entities involved in the sector, and which made field visits to Bank-funded Project sites.Information was also obtained from postevaluation and Project Completion Reports of the Bankand the World Bank, and previous Bank TA reports, notably, the Study on Monitoring the Impactof Policy Changes and Investments on the Tree Crop Sector.5 Where possible, the IES is alsobased on reviews and preliminary results of the ongoing Bank-assisted projects.

II. BACKGROUND

A. General Features of the Tree Crops Subsector

6. In 1995, the main tree crops, ranked in terms of crop area, were coconut, rubber,oil palm, coffee, cocoa, cashew, and tea. Their combined area was 11.6 million hectares (ha)(see Appendix 3).6 The situation was quite different in the late 1960s when the Bank firstbecame involved in the sector. At that time, the total tree crop area was only 4.6 million ha anddominated by rubber and coconut. The areas of oil palm, coffee, and tea were small, and

cashew was an insignificant crop. For the period from 1970 to 1995, there was a steady growthof 3.6 percent per annum in the tree crop area combined with a rapid rise in the importance ofoil palm, and, to a lesser extent, cocoa and cashew. These trends are expected to continue overthe foreseeable future.

7. While the major tree crops are grown throughout Indonesia, there is apronounced concentration in western Indonesia.7 Most of the rubber area is on Sumatra andJava, and in the province of West Kalimantan. Oil palm is concentrated on Sumatra and in WestKalimantan, and tea, on Java. Eastern Indonesia accounts for less than 30 percent of the totalarea of the major tree crops. The dominance of western Indonesia comes from the areasclimatic suitability for tree crops, the historical population distribution pattern, and theconcentration of the early private estates in these areas.

4 TA No. 2590-INO:Assessment of the Effectiveness of Bank Assistance to the Industrial Crops and Agro-Industry Sector(1969-1995), for $100,000, approved on 18 June 1996.

5 TA No. 1836-INO for $450,000, approved on 31 December 1992.6 Sugar and cotton which have received one Bank-assisted project each occupied 405,000 ha and 34,000 ha, respectively.7 The islands of Sumatra and Java, and the province of West Kalimantan.


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8. In the early 1970s, a little over 80 percent of the tree crop area was owned bysmallholders. The other two producer types are the Government estate companies (referred toas Perseroan Terbatas Perkebunan or PTPs) and the private estates which each owned about8 percent of the total area. Since then, and more particularly, since 1986, the private estatesubsector has grown rapidly and accounted for 14 percent of the total tree crop area by 1995. In1995, smallholders accounted for about 79 percent of the area, and the PTPs, 7 percent.

Whereas coconut, rubber, coffee, cocoa, and cashew are predominantly smallholder crops, oilpalm and tea are predominantly produced by the private estates and the PTPs. Despite therelatively rapid growth in the proportion of land owned by private estates, the major increase intree crop area has been of that owned by smallholders.

9. Smallholdings are about 0.5 to 2.5 ha in size. Both food and tree crops areproduced. Production typically uses low levels of inputs, and outputs are generally sold in theirmost basic and simple forms, such as lump rubber as opposed to smoked sheets or latex, driedcocoa beans as opposed to fermented beans. Except in the case of oil palm fruits which in mostcases are sold to nucleus estate mills (see para. 10), the marketing of smallholder tree crop

produce involves a network of village agents and several levels of private traders. Whileeffective in collecting and channeling the myriad small quantities from the smallholders, thissystem does not normally provide incentives for producing higher quality outputs.

10. A growing group of smallholders are those in NES schemes. Typically in theseschemes, undeveloped areas are brought under cultivation and smallholders from nearby areasor transmigrants from other provinces are settled in the area and provided with land, houses,and community facilities. In the case of schemes with tree crops, smallholders are normallyallocated two to three ha including one to two ha of tree crop that was planted for them underthe projects. A nucleus estate which normally also has facilities for the processing and

marketing of both smallholder and nucleus estate production is established adjacent to thesmallholder area. Most of the early established NES schemes are operated by the PTPs, butfrom 1985 private entities have been encouraged to also participate in this type of scheme. Theratio between the crop areas for the smallholders and the nucleus estate was initially 60:40, butchanged to 80:20 in the mid-1980s.

11. The PTPs are Government-owned corporations which evolved out of the estatecompanies formed to take over the Dutch estates nationalized in the late 1950s and otherGovernment estates. Since the time of their formation, many changes have occurred in theirstructure and form.8 They produce a range of tree crops, other industrial crops such as sugar

and fibers, and livestock. Although the PTPs are autonomous and, financially, are to operateindependently of the Government budget, they are Government corporations and retain somesocial functions. Large numbers of staff and regulations on their operations also constrain theextent to which they may act in true commercial fashion. Beginning in 1977, the PTPs were

8 Currently, i.e., in 1996-1997, they are undergoing a further change to become 14 separate Perseroan TerbatasPerkebunan Negara (PTPN), organized according to geographic coverage. In this Report, the earlier PTP structure isdescribed and analyzed since the available data is organized according to the older PTP structure and has not yet beenreorganized by PTPN.


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used as development agents for smallholders through their involvement as NES schemeoperators.

12. Although there are a large number of private estates, 60 percent have land areas

of less than 1,000 ha. Only 33 companies have areas of over 10,000 ha and of these, sixcompanies stand out as being large, diversified conglomerates with over 100,000 ha of treecrops each. About 100,000 ha are controlled by foreign companies. The land of the privateestates is held under leases of 35 years, extendible for a further 25 years. While the largerprivate estates appear to achieve yields and efficiencies that can match or exceed those ofMalaysian companies, the smaller estates typically suffer from inadequate management andinvestment in infrastructure, and, as a result, often achieve poor financial results.

B. Government Development Objectives and Support

13. In the 1970s, economic growth was a major development goal. To achieve thegrowth objective, an increase in foreign exchange earnings, particularly in the public sector wasviewed as important. This meant that the public sector was to assume a direct role in productiveactivity, and developments which enabled import substitution or increased foreign exchangeearnings were favored. Later, with the collapse of the mineral oil prices following the oil crises ofthe 1970s, diversification of the countrys export base increased in importance. Self-sufficiencyin food, including cooking oil, poverty reduction and a more balanced regional spread ofdevelopment were added as explicit national goals in the early 1980s. In more recent years,environmental protection and sustainable development have gained in importance. Currently,the important goals are sustainable economic development coupled with export diversification,poverty reduction, a better regional balance in development and protection of the environment.

Food self-sufficiency and public sector expansion also still remain as goals.

14. Throughout the period from the 1970s onwards, the tree crops, as well as otherindustrial crops, and the PTPs which maintained estates of industrial crops were viewed asvehicles for achieving the national goals. Although smallholders were included in some earlydevelopment efforts,9 it was only from the start of the 1980s that major efforts were made fordevelopment of smallholder tree crops. Active encouragement of the private sector10 startedlater, from the mid-1980s when special credit programs were introduced and the process ofgranting land use permits for tree crop estates was improved.

15. The Government provides general guidance and technical support for the treecrops subsector through the Directorate General of Estates (DGE). Following the devolution ofmany responsibilities to the provincial level, regular operations within the subsector at thesmallholder level are undertaken by the provincial extension service for estate crops (Dinas

9 For example, the Bank-funded Fiber Production and Processing Project(Loan No. 189-INO), approved in 1974had a smallholder component.

10 In this Report, the term private sector is meant to comprise private corporations, and excludes smallholders.


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Perkebunan) in each province. It is significant, however, that the majority of the smallholder treecrop area does not receive assistance from Government, and that the large expansion insmallholder area was largely done by the smallholders themselves. The Dinas Perkebunan isconstrained by limited resources, operational budget and staff capability. In addition to itsgeneral support, the Government has provided specific assistance to smallholders throughprojects which have been of two main types. The first type comprises the NES schemes which

have been implemented by the PTPs. Under the second type of project, referred to as ProjectManagement Unit (PMU) projects, existing smallholders are assisted with technology, credit andsimple crop processing and marketing support channeled through a PMU organized by theDGE. The DGE has a special team (Tim Khusus), which provides assistance to the PMUs onprocurement, budgeting, recruitment, start-up activities, and legal matters. Where the PTPs arethe implementing agencies, the role of the DGE is mainly supervisory and advisory in nature.The Governments projects have supported about 11 percent of the smallholder tree cropproducers, comprising about 5 percent under NES schemes and 6 percent under PMU projects.Direct special support for the private sector has been limited to subsidized credit, particularly forprivate NES projects. Termination of the subsidized credit in 1990 coincided with reducedinterest by the private sector in private NES projects.

C. Investment Within the Subsector

16. A total of $9.2 billion was estimated to have been invested in the tree cropssubsector from 1969 to 1993 (see Appendix 4). About 59 percent of the investment was madeby, or for, smallholders. A further 26 percent was for private sector estates, and the balance wasfor public estates. By crop, the largest investment was for oil palm ($2.9 billion), followed bycoconut ($2.1 billion), and rubber ($2.1 billion).

17. Foreign assistance for the tree crops subsector totaled $1.53 billion or 17 percentof the total subsector investment. The World Bank has been the major contributor, havingprovided $909 million up to the end of 1993. The Bank provided $491 million, equivalent to 32percent of the external assistance, and about 5 percent of the total investment within thesubsector, over this same period. Other major sources of financial assistance have been theInternational Fund for Agricultural Development, Germany, the United Kingdom, and SaudiArabia.

D. Bank Assistance (1969-1995)

18. The Banks assistance has followed the Governments development directionsand strategies (see Table 1 and Appendix 5). Thus, the first five projects, implemented from1970 to 1981, aimed primarily to expand and rehabilitate public sector plantations andprocessing facilities. The key goals for these earlier projects were increases in non-oil exportsand public sector foreign exchange earnings. Although smallholders were involved in some ofthe earlier projects, it was not until 1981 with Loan No. 499-INO:Palm Oil Processing andSmallholder Development that smallholder development became a primary focus. From 1981 to


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1988, the Bank financed six projects, all of which were directed wholly or partly towardsimproving smallholder incomes. Five of these projects were NES schemes. In addition toimproving conditions for smallholders, improvements in food security, export diversification andforeign exchange earnings, and the regional balance of development were important goals inline with the overall Government objectives at the time (see para. 13).

19. Towards the end of the 1980s, the NES approach was replaced by the PMUapproach in Bank-financed projects. The PMU approach focused entirely upon existingsmallholders. Whereas the NES schemes were concerned with new area development, thePMU-based projects were designed to assist smallholders in existing farm areas. At this timealso, in accordance with the Governments objectives, emphasis was given to environmentalissues and the sustainability of development, such as by explicitly basing crop improvements onsustainable forms of agriculture, moving away from commodity-based projects to ones whichwere concerned with farming systems (e.g., upland farming) and introducing integrated pestmanagement (IPM).

Table 1: The Bank-assisted Projects

Loan Implementation Main Beneficiaries Main CropsImplementation

No. Period Method a

15 1970 to 1975 PTP Oil palm PTP63 1971 to 1976 PTP Oil palm and rubber PTP

148 1974 to 1987 PTP and smallholders Sugar PTP189 1975 to 1980 PTP and smallholders Kenaf, jute PTP235 1976 to 1981 PTP Oil Palm PTP499 1981 to 1987 PTP and smallholders Oil Palm NES517 1981 to 1988 PTP and smallholders Cotton NES682 1984 to 1991 Smallholders Tree crops DGE687 1985 to 1992 PTP and smallholders Oil Palm NES789 1987 to 1994 PTP and smallholders Oil Palm NES910 1988 to 1995 PTP and smallholders Cocoa NES

1118 1992 - ongoing Smallholders Rubber and tea PMU1184 1993 - ongoing Smallholders Upland crops PMU1186 1993 - ongoing Smallholders Rubber and oil palm PMU1258 1994 - ongoing Smallholders Tree crops PMU1351 1995 - ongoing Smallholders Upland crops PMU1469 1996 - ongoing Smallholders Tree crops DGE

aPTP: implemented by the PTP using its normal management structure.NES: NES scheme implemented by PTP.DGE: implemented by DGE/other agencies using Project Management Offices.PMU: implemented by DGE using Project Management Units.


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20. The reasons why the Bank changed away from NES projects to the PMU- basedprojects are not clear. However, it parallels a similar change in the design of World Bank-financed projects. One probable reason is the higher development cost per beneficiary of NESprojects compared with PMU projects. The cost, in constant 1996 values, of the smallholdercomponents of the NES projects has ranged from $7,127 to $21,614 per beneficiary (seeAppendix 6). The NES cotton project was much lower, because of the absence of land

development. In contrast, the cost per beneficiary of the PMU-type projects is much lower,ranging from $441 to $1,524 in 1996 values. While this cost data tends to favor the PMUapproach, it must be tempered by income expectations which are higher for beneficiaries underthe NES projects than those under the PMU projects. The NES projects provide one to threehectares of crop land per beneficiary and smaller allocations would have produced costs andincomes per beneficiary in line with those achieved under the PMU projects.

21. In the NES projects, less than 5 percent of the project cost was expended forinstitution building, such as staff training, consultants, and project management. This is becausethe PTPs which implemented the NES projects have had adequate expertise and experience,

partly built up through successive Bank-assisted projects. In contrast, institution building in thePMU projects comprises 20 to 30 percent of the project cost.

22. The six Bank-supported oil palm based projects form a sequential development.The first projects built up expertise within PTP II. Under Loan No. 499-INO, PTP II was used toimplement a pilot NES Project. Based on the initial successes of this pilot, a further two NESprojects with oil palm and two NES projects based on other crops were commenced. The TreeCrop Smallholder Sector and Smallholder Tree Crop Processing Projects (Loan Nos. 1118-INOand 1186-INO) approved in 1991 and 1992 form another combined effort to uplift smallholderproduction by attacking production and processing problems in the same general area. These

will also be supported by the latest approved project which provides for IPM. In comparison, theother projects for cotton and cocoa/coconut appear as individual, one-off efforts to develop aparticular area or group of smallholders, and do not appear to form part of an overall long-termdevelopment plan.

23. Of the Banks TA program, 17 TAs have been for project preparation and 8 TAswere operational and advisory. All but two of the project preparatory TAs resulted in loanprojects. Three of the operational and advisory TAs provided inputs into loan projects, while fourgenerated sector information, and one provided information for this IES.

E. External Factors

24. International prices, exchange rates, interest rates, and Government controls onland and trade are the main external factors affecting the sector. All of the outputs of the Banksprojects are internationally traded and have been affected by falling international prices. The fallin prices was significant over the period of the 1980s. Oil palm and coffee prices have improved


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since 1990, but prices for the other supported tree crops, i.e., tea, rubber, and cocoa haveremained low. During this time, inflation was relatively high which increased the cost ofproduction, but the effect on profitability was compensated by depreciation of the exchange ratewhich, particularly for oil palm, kept output prices expressed in rupiah at attractive levels.

25. Throughout most of the 1970s and 1980s, the Government tightly controlled thetrade of oil palm in all its various forms, copra and coconut oil, and coffee. The trade in othercommodities has not been regulated. Palm and coconut oils are the main cooking oils in thelocal market and the effect of the controls was to channel a large part of output into thedomestic market. This was in line with Governments objective of ensuring self-sufficiency inbasic commodities. Domestic prices have generally been high relative to international prices.Nevertheless, the controls distorted the market. There are also a number of export taxes whichdistort the market. Many of the controls on coconut and palm oils have been relaxed, but thetrade in these commodities, along with rubber products, continues to be monitored.

26. On the supply side, the development of estates has been controlled through theissuance of business permits and access to land. These have slowed down the rate ofdevelopment of private estates. High domestic interest rates which help to channel domesticsavings into financing the national current account deficit also restrict private sectordevelopment.

III. IMPACT OF BANK ASSISTANCE

A. Contributions to Production

1. Crop Production

27. The Banks completed projects have utilized technology that was up to date andcomparable with that used in similar non-Bank funded developments. The impact on cropproductivity has been mixed. It has been generally good for oil palm, rubber and sugar, but lesssatisfactory for cotton, cocoa, and coconut. However, in terms of the overall sector, a significantimpact on production so far has been achieved only with oil palm. This is because oil palm isthe only crop whose area and production have been significantly expanded under the completedBank-financed projects.

28. For oil palm, the Bank assisted the rehabilitation of 6,400 ha and the newplanting of 41,000 ha under six of the completed projects. Although this represents only around2.5 percent of the oil palm area, it has been concentrated in three provinces, namely, North


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Sumatra, Riau, and Irian Jaya which enhances its visibility and impact. Smallholders associatedwith NES schemes own 65 percent of the assisted area, while the balance is owned by PTP II inthe nucleus estates of NES schemes or as stand alone estates. Establishment and rehabilitationof the oil palm area were satisfactorily done. This was because all of the area, including that forsmallholders, was established as large scale plantations, and was done by PTP II which hadappropriate experience and expertise, largely built up through the implementation of successive

Bank-funded projects.

29. Average peak yields of the Bank-assisted oil palm areas exceed 20 tons (t) perha of fresh fruit bunches (FFB). These are double those prevailing before the Banks initialinvolvement, but are about 10 to 15 percent less than those obtained by private estates, andabout 10 to 25 percent less than projected at appraisal. The satisfactory yields are due, in part,to the incorporation in the projects of the high yielding varieties of oil palm, the introduction ofpollinating insects, and improvements in fertilizer management. The smallholders normally useless fertilizer and obtain slightly lower yields than the nucleus estate. The establishment,operation, and yield of the Bank-assisted oil palm areas are similar to those of the areas

developed under non-Bank projects. Like those other areas, further improvements in fertilizeruse are possible, including the use of fertilizers other than urea as the source of nitrogen. Thelow rates of fertilization by oil palm smallholders and the PTPs will cause premature yielddecline. However, the strong profitability of the crop means that it will remain sustainable evenwith a significant yield decline.

30. Under the completed projects, the Bank support for rubber has been small,comprising new planting on 6,100 ha and the rehabilitation of a further 16,200 ha, a rather smallarea in comparison with the total rubber area of 3.5 million ha in Indonesia. All of the Bank-supported area was owned by PTP II and was provided for under a single project, TA No. 50-

INO:North Sumatra Rubber and Oil Palm Project. Direct support for smallholder rubber was onlyprovided under later projects which are still under implementation. The PTP II has achievedgood yields of 1.5 to 2.0 t per ha of rubber which are comparable to plantation yields elsewherein Indonesia and double those achieved by the PTP prior to the Banks involvement. In view ofoil palms higher profitability, some of the rubber areas have been replaced by oil palm, andfurther replacement is expected in the future as the rubber trees age.

31. The single project for cocoa and coconut, the Nucleus Estate and SmallholderCocoa/Coconut Project (Loan No. 910-INO), substantially failed to achieve its area targets.Overestimation of the suitability of the selected site at the time of Project planning, problems

with pests and poor management during planting resulted in less than 30 percent of the 9,100ha of cocoa and none of the coconut being established. The initial smallholder yields have beenhigher than the nucleus estate. However, all yields have been low, less than 500 kg per ha ofdried beans due to infestations with pod borer and insufficient fertilizer application. Pod borerpresents a major and difficult to overcome obstacle to improvement of the Project and furthercocoa development in the area. Non-project supported smallholders in the same provinceobtained much higher yields of up to 1.5 t per ha of dried beans, but these yields are for areasnot yet infested with pod borer. A private estate in the same area experienced poorer cropestablishment and had similar, low yields as obtained in the Project area.


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32. The Nucleus Estate and Smallholder Cotton Project (Loan No. 517-INO),implemented in South Sulawesi, was the Banks only project for cotton. Although the areatargets were initially met, they were not sustained. The Project design assumed that yieldswould increase from the preexisting level of 1 t per ha to 1.5 t per ha. However, average yields

over the expanded crop area were much lower while production costs were high due to pestproblems and the need for expensive control measures. Compared with before the Project,farmers currently achieve about half the yield, i.e., 0.5 t per ha of seed cotton, and the area ofcotton is less. Cotton requires significantly more purchased inputs than alternative crops and isthus more risky under rainfed conditions. Where irrigation is available, farmers prefer to growrice which generates a higher net income. The Bank-financed East Java Sugar Project was notreassessed for this study. The Project Performance Audit Report, prepared in 1981, noted thatrice was more profitable for smallholders than sugarcane which caused underachievement ofarea and output targets in one of the Project areas.

33. In addition to site specific developments, two of the Banks projects hadcomponents which were of national scope. The North Sumatra Rubber and Oil Palm Projecthelped improve the capability of the Research Institute of North Sumatra Planters Associationfor leaf analysis and fertilizer need determination. This facility has been used by all the PTPs,although the interpretation and implementation of the results have not always been doneproperly. Under the National Estate Crop Protection Project, biological controls were developedfor the rhinoceros beetle pest of oil palm and coconut, white root disease of rubber and thecoffee borer and have benefited producers in many parts of Indonesia.

34. The initial experience from the ongoing projects utilizing the PMU approach to

develop existing smallholders suggests that the expected output targets may not be fullyachieved. Smallholders do not use high input, high output production systems. Further, theprevailing market system discourages high quality by using only product weight to determinecrop value.11 Consequently, some of the appraisal assumptions regarding beneficiaryparticipation, the effectiveness of extension services to cause change in production systems,and Project yields appear overoptimistic at this stage. The replanting program where trees oflow productivity are replaced by higher yielding varieties is expected to give the best results.However, there are indications of variable quality in tree establishment and maintenance. Therealso are doubts that the developments will be adequately supported at the end of the projectimplementation period. After project completion, the provincial staff must take over thesmallholder support functions using their regular budget which is generally inadequate tomaintain the level of services provided under the PMU.12

11 The advantage of using only weight is its simplicity: the need to negotiate over quality characteristics is eliminated andseparate receiving bins for different quality grades do not have to be kept. Traders claim that before higher prices canbe offered for better qualities, they would have to receive large volumes of the better grades to justify keeping thegrades separate and to enable them to sell the better grades as a separate lot. This would require simultaneous changeto producing better grades by many smallholders.

12 The issue of long-term support is expected to be reviewed under an advisory TA for sustainable project managementfor tree crop development planned by the Bank and the Government.


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38. The Sawit Sebarang oil palm refinery operates below capacity, producing about30,000 to 50,000 t of product per year, compared with its rated capacity of 60,000 t per year.The plant and equipment were well designed and installed. The low throughput is mainlybecause PTP II obtains higher profit from selling its oil palm output in crude form than as a

refined product to domestic wholesalers. The small size of the refinery limits the ability of PTP IIto develop a brand name which would enable it to obtain a higher price by selling refinedcooking oil to retailers in competition with established private operators.

39. Rubber processing facilities were included in only one of the completed Bankprojects, the North Sumatra Rubber and Oil Palm Project. The expansion and new works for thetwo crumb rubber factories and one latex factory were satisfactorily completed. They operate atabout 20 to 40 percent capacity, however, due to lower than expected raw material availability.Consequently, production costs are high. The shortfall in raw material supply results fromunfulfilled expectations about rubber expansion, and the conversion of some of the rubber areas

to oil palm due to high losses of rubber trees from wind damage and the higher profitability of oilpalm. The ongoing Smallholder Tree Crop Processing Project also supports smallholder rubberprocessing and four crumb rubber factories. The smallholder units are intended to enablesmallholders to produce dry sheets rather than unprocessed lump rubber which they have beenproducing in the past. However, slow adoption has occurred due to the absence of a clearincentive, in the form of higher prices, to produce the sheets.

40. The ginnery for processing cotton provided under the Nucleus Estate andSmallholder Cotton Project was satisfactorily established, but in recent years has operated foronly a few weeks per year due to the decline in cotton production in the area. A nearby mill

which existed prior to the Project also operates for only a few weeks per year. Processingfacilities for cocoa, operated by the NES, were included under the Nucleus Estate andSmallholder Cocoa/Coconut Project. A price premium is not received for fermented beans and,therefore, the processing involves simple sundrying without fermenting. Wood fired dryers werealso established but taint the cocoa beans and are not used anymore. The expected large inflowof beans from smallholders also has not occurred due to low output and the sale bysmallholders of the majority of their beans to private traders who pay higher prices than thenucleus estate. One of the two sugar factories supported by the Bank in East Java also sufferedfrom low operating throughput due to inadequate supplies of cane.

3. Industry Policies and Structure

41. The main impact on the policy environment has come through the Banks TAactivities and has concerned oil palm. The recommendations of TA No. 1146-INO:Pricing andDistribution Policies for Vegetable Oil and the subsequent outputs of a staff consultant toformulate a vegetable oil policy were embodied in the deregulation package for vegetable oilsimplemented in 1991. Among the features of this package was the termination of import andexport controls on oil palm and the use of market forces to determine the price of oil palm in the


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local market. TA No. 1879-INO:Study on Enhancing the Role of the Private Sector in Tree CropDevelopment and TA No. 1836-INO led to the relaxation of restrictions on both local and foreignprivate sector investments in the sector. All of these policy changes, aimed at deregulation ofthe industry, have contributed to the rapid growth, currently 13 percent per annum, in the areaunder oil palm. Further strong growth is expected, but due to the remaining restrictions, thescope for involvement by smallholders is limited (see paras. 67-68).

42. The Banks projects funded about 20 percent of the NES oil palm area in NorthSumatra and Riau. Supported by the deregulation initiatives, this appears to have been acatalyst in promoting private investment in oil palm, including the establishment of private NESprojects, in these provinces. By 1994, the area of oil palm established by the private sector inSumatra had risen from around 50,000 ha at the time the Bank became involved with oil palmdevelopment to almost 323,000 ha including 207,000 ha of private NES type developments.Most of the expansion of private sector oil palm occurred from 1988 onwards. The Bank was apioneer of the NES approach in Sumatra, and financed a large proportion of the early oil palmplanting in Riau. A key development in Riau was the Nucleus Estate and Smallholder Oil Palm

Project which established two NES schemes in the area. This was followed by the SecondNucleus Estate and Smallholder Project with a further NES scheme in Riau. The SecondNucleus Estate and Smallholder Project also established an oil palm NES Project in Prafi, IrianJaya. Although only a single development, it is expected to demonstrate the viability of oil palmproduction in Irian Jaya. Similar demonstration effects are not evident for the other crops. Thismay be because of poor Project results, such as occurred for the projects involving cotton andcocoa, and/or the lack of clear incentives in the form of market opportunities and product price,such as for sugar and rubber.

B. Socioeconomic Impact for Smallholders

43. Overall, smallholders under the various Bank-assisted NES projects claim to besatisfied with the results.13 The beneficiaries share the view that the projects had increasedtheir incomes, provided their families with employment opportunities, promoted a spirit ofcooperation in agribusiness activities and provided opportunities for self- reliance. The projectshad also provided basic infrastructure such as rural roads, primary schools and health services,although farmers expressed concern that secondary schools were lacking and the maintenanceof facilities was inadequate. However, the claims by the beneficiaries are based uponcomparisons with their previous or alternative situations, and in some cases repayment of thedevelopment costs has not yet been required. Consequently, some of the claims need to bequalified. In the case of oil palm, the impact of the NES projects on the beneficiaries

socioeconomic position is substantial (see para. 44) and despite qualifications, a relatively clearpositive result emerges. The impact is less marked and not as clear for the other crops (seeAppendix 8).

13 A survey of 180 farmers within, and adjacent to, the areas of the completed Bank projects was undertaken for the IES.Econometric models and field assessments provided additional information.


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44. Approximately 13,675 farm families in the Bank-assisted NES oil palm schemescurrently receive over Rp7.5 million per year on average from both farm and off-farm sources.About 70 percent of the total income comes from oil palm. This income is more than six timeshigher than the poverty level income for rural Indonesia14 and higher than appraisalexpectations which typically were about Rp5.5 million per family per year (in 1996 values).Unassisted farmers in the surrounding areas had other crops and received less than half these

incomes. Although this high-income level is due to currently high international prices for oilpalm, the income expectations under the lower World Bank projected prices up to 2010 remainmuch higher than the poverty level (see Appendix 9). The high incomes of the beneficiaries areevident in the quality of their houses and the number and type of their household assets.Repayment rates by smallholders for the oil palm developments are also high. For example, 100percent of the smallholder costs under Loan No. 687-INO and about half of those under LoanNo. 789-INO have been recovered. Full repayment under Loan No. 789-INO is not expecteduntil 2001. In addition, some farmers have grouped together and have collected annualcontributions to fund their future replanting program. The attractive income potential of oil palmis also evident in Sei Buatan where nearly all the non-project farmers surrounding the Bank-assisted NES Project have planted oil palm on their own initiative.

45. The average incomes of the 3,044 farm families in the cocoa NES project areabout Rp2.3 million per family per year of which 60 percent comes from cocoa. These farmincomes are well above the poverty income level, but the farmers do not yet make repaymentsfor their share of the costs of the plantation development. Their average debt for thedevelopment is about Rp7 million. With the proposed interest charge of 16 percent per annum,the annual repayment would be over Rp1 million per year and the household income wouldreduce to the poverty level. Cocoa farmers outside the Project obtained better yields but hadsmall farms and earned only about two thirds of the income of the project beneficiaries.Although those farmers growing cotton in the NES cotton project area are satisfied with theincome received, cotton contributes less than 20 percent of their total gross income. There are

relatively few farmers who still grow cotton compared with the appraisal expectations or thenumber that tried cotton during the project implementation period, and the impact of the NEScotton project on poverty alleviation is small.

C. Financial Impact on the PTPs

46. Under the completed Bank projects, the PTPs were major beneficiaries. Most ofthe assets created under the projects and other development activities were passed on to thePTPs through loans with interest rates of 12 percent for the oil palm projects, 13.5 percent for

the cotton project and 16 percent for the cocoa/coconut project. The costs of the smallholderdevelopments are eventually passed onto the smallholders through subsidiary loans betweenthe PTP and smallholders. Repayments from smallholders are to be collected from the sale ofproduce delivered to the PTP for processing. This arrangement for recovery of developmentcosts from smallholders has worked well only for the oil palm-based NES schemes. This is dueto the strong dependency of the smallholders on the NES operator, i.e., the PTP, to purchase

14 The Central Bureau of Statistics, 1995 defined the poverty level as Rp232,000 per capita per year or Rp1.16 millionper family of 5.0 per year.


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their output. The NES operator can deduct the debt repayment directly from the sale proceedsof each smallholders output. For cotton, cocoa, rubber and many other crops, the outputs caneasily be stored and/or transported long distances and the smallholders are not so dependentupon the NES operator to buy their produce. In such cases, such as in the cotton and cocoaprojects, debt recovery has been poor and the PTPs have to shoulder large financial burdens.

47. Since the start of the Banks involvement in the sector, the fixed assets and netsales of each of the three PTPs participating under the Bank-assisted projects, i.e., PTP II, PTPV, and PTP XXIII, have increased significantly (see Appendix 10). In all cases, the expansionhas been financed through long-term loans, including subsidiary loans related to activities andassets created under the Banks projects and the debt equity ratios, while being acceptable, arehigh. Of concern is the relatively low financial internal rates of return for the Bank-financedinvestments of the PTPs and the relatively low returns to total assets15 when compared to theinterest charged on borrowings from the Government. While it was anticipated at appraisal thatthe profits from the Bank-assisted projects would improve the PTPs debt/equity ratios, this hasnot occurred. The high debt burden, and the resulting high annual interest charges, will limit the

ability of the PTPs to undertake large-scale replanting programs or new expansion projects.

48. In financial terms, PTP II is currently rated as one of the better PTPs inIndonesia. PTP V is average and PTP XXIII is among the weakest. The strength of these PTPsis related to the type of enterprises they operate, and in particular, the amount of oil palmdirectly grown by them. Both PTP II and PTP V have large oil palm enterprises. Oil palm is oneof the most profitable industrial crops in Indonesia and the oil palm activities contributesignificantly to the financial performance of these two entities. More than two thirds of the oilpalm processed by PTP II comes from its own estates whereas PTP Vs own oil palmcontributes only half of its mill throughput. While processing oil palm is profitable, growing oil

palm is more so, and this difference in the structure of the oil palm enterprises of these twoPTPs underlies the stronger financial performance of PTP II.

49. In contrast to the situation for the other PTPs, PTP XXIII has enterprises basedon less profitable crops such as coffee, tea, cocoa, rubber, and cotton. The Bank projects forcotton and cocoa have not been successful. The major part of the investment costs of theseprojects have been passed on to PTP XXIII and these have now become a major financialburden.

D. Economic Impact

50. The oil palm projects assisted by the Bank are making significant contributions tonational output, foreign exchange earnings, and labor employment which were important goalsof the projects. For a total investment of around $252 million in 1996 values, the 1996 annual

15 The returns to total assets of the PTPs over the 1991 to 1994 period were 7 percent for PTP II, 4.5 percent for PTP V,and 2 percent for PTP XXIII.


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production for the completed oil palm projects was about 180,000 t of crude oil palm and 40,000t of palm kernel with a combined foreign exchange value, from export or import substitution, of

just under $100 million. The aggregate incremental production of these Bank-supported oil palmprojects over their economic lives is expected to be about 14 million t of oil palm and just over 3million t of palm kernel, together valued at $7.5 billion. The projects have provided about 10,400agricultural jobs on the estates and nucleus estates of PTP II as well as employment in the mills

and on the 13,675 smallholder farms. These benefits are reflected in satisfactory economicinternal rates of return (EIRR) which were reestimated as part of this impact analysis to beabove 10 percent for all the oil palm-based projects (see Appendix 11).

51. The North Sumatra Rubber and Oil Palm Project also provided new employmentfor 2,400 agricultural workers engaged in rubber and, through rehabilitation of existing cropareas, supported the continuation of work for a further 6,900 rubber industry employees. Theincremental rubber output is expected to reach 0.4 million t by the end of the Project. Incomparison to the satisfactory contributions of the oil palm and rubber projects, the Bankscotton and cocoa/coconut projects have increased output, foreign exchange earnings and

employment only by small amounts, reflected by negative reestimated EIRRs. The economiccontributions of the Banks other projects in the sector were not reevaluated; however, atpostevaluation in 1981, the EIRR of the East Java Sugar Project (Loan No. 149-INO) wasreestimated at just over 10 percent.

E. Institutional Impact

52. The institutional impact of the completed Bank-assisted projects has beengreatest for the PTPs since these entities were responsible for implementing the NES and

estate projects. Although the formal training of PTP staff under projects has been minor, thePTPs gained from consultant inputs and experience in project implementation. This experiencecould be used in future projects appropriate to the role of the PTPs as profit-orientedcorporations, such as private NES projects.

53. The PMU projects are implemented by the DGE through its Tim Khusus. Thetraining and experience gained from the Bank projects have strengthened DGEs capability forproject implementation. Nevertheless, these ongoing projects do suffer from delays and otherimplementation difficulties highlighting a continuing need for staff training and consultantsupport. Such need also will come if project designs change to incorporate greater beneficiary

participation, and non-technical components, such as those for community development.

54. The National Estate Crop Protection Project (Loan No. 682-INO) expanded theDGEs capacity for pest monitoring, research, and control. However, staff movements,inadequate maintenance of the facilities, and weak field operations have reduced the capabilityof the service. A reversal of this decline is expected as a result of a recently initiated second


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project, the Integrated Pest Management for Smallholder Estate Crops Project (Loan No. 1469-INO), approved in September 1996.

55. A critical area appears to be the need to provide long-term field support to

smallholders, including those who have been beneficiaries under Bank-assisted projects. Asprojects move from implementation to operations, the responsibility for support passes from aresource rich PMU to a generally resource poor office under the provincial Government. Staffcapability limitations, weak operational plans, and small operational budgets are the most criticalconstraints of the provincial service. Most of the completed projects, particularly the oil palmprojects, have not been affected by this as they were implemented under the NES arrangementand receive continuing support from the PTPs. A strong link between smallholders and thePTPs has developed due to the dependency of each on the other; the smallholder on the PTPto buy the output, and the PTP on the smallholder for the supply of material for the mills.

56. Farmer groups have developed in many of the Bank-assisted NES oil palmprojects. The more successful groups employ full-time staff and have purchased trucks andtransport smallholder produce to the mill. They also bulk purchase fertilizers for their membersand operate retail stores. These farmers groups receive, and pass on to members, thepayments from the mill for the sale of produce, and maintain group financial accounts. In the lasttwo years, some have started group savings schemes whereby funds are set aside for futurecrop replanting.

F. Environmental Impact

57. The main threats to the environment from the Bank-assisted projects have comefrom the conversion of forested lands to agricultural use, the use of agrochemicals, and thedisposal of wastes from the oil palm and rubber processing facilities. Overall, the impact hasbeen minor as discussed below.

58. The conversion of lands to oil palm has had little negative environmental impact.This is because, apart from the initial land clearing, soil cultivation is minimal. The Bank-assisted projects established legume cover crops after land clearing which minimized soilerosion. Although the rubber and cocoa areas were established in a similar manner, thecultivation of these crops presents added erosion risk, especially on hilly terrain. This is becausethe heavy leaf canopy prevents the establishment of ground cover. However, the cocoa areasdid not show evidence of severe or large-scale erosion. The projects for cotton, sugar, and fiberwere implemented on predominantly bunded rice land and would have incurred minimal soilerosion. The main environmental risk in project establishment lies with the food crop componentof NES projects. After clearing, these food crop areas are not fully utilized and become heavilyinfested with alang-alang, a difficult to eradicate weed. Particular emphasis was given in thedesign of the Bank-supported projects for the use of flat land for food crop cultivation, but this


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was seldom achieved in practice and the intensive cropping in hilly terrain carries the risk oferosion.

59. The environmental risk related to pesticide application occurs mainly with cotton

which suffers from significant pest infestation. Recent developments include the introduction ofpest resistant varieties and training in IPM which should lessen the environmental risk. TheBank-supported National Estate Crop Project also spread the concepts of IPM with emphasis onbiological control methods. Notable achievements include the biological control of rubber whiteroot disease, rhinoceros beetle pest in coconuts and oil palms and coffee borer. The Banksrecently financed second project for estate crop protection is expected to continue this work.

60. All of the processing plants established under the Bank-assisted projects havefacilities for the collection and treatment of liquid effluent. The quality of design and constructionof these facilities has been mixed. The anaerobic ponds at the Sawit Sebarang oil palm mill are

of the best design, although the ponds at the other factories are workable. The ponds at the SeiGaro oil palm mill were poorly constructed. Except at the Sei Garo and Sei Galuh oil palm millswhere the liquid effluent ponds are not adequately maintained, the final discharge liquid wastesare within established limits, albeit just so for some. In general, operation of all of the wastetreatment facilities can and should be improved to give a larger safety margin and to complywith the forthcoming lowering in the tolerable limits on waste water quality. Waste empty fruitbunches at the oil palm mills are presently burned, partly to generate steam, which produces anundesirable emission of ash. Legislation is in place to eliminate this practice in 1997. The emptybunches will be used as mulch in the oil palm plantations. This has been shown to improve cropproduction in Malaysia, particularly in areas where moisture stress occurs. To date, themulching of empty bunches has been minor.

IV. ISSUES

A. Development Planning and Ownership

61. As a group, the Bank-supported oil palm projects followed a sound long-termdevelopment approach which progressively built up information and capabilities so that morecomplex activities could be undertaken with minimum risk. The earliest projects involved onlyestate development by PTP II which enabled the expertise of PTP II to be built up. Using thisexpertise, the NES oil palm concept was introduced as a pilot project for 500 households underLoan No. 499-INO. The experience gained with the pilot was then used to undertake larger NESoil palm projects under Loan Nos. 687-INO and 789-INO, all implemented by PTP II. In contrast,the other Bank projects in the sector involved different crops, different provinces, and differentimplementing agencies and are largely ad-hoc undertakings not forming part of any long-termdevelopment plan for an area, community, or crop. While the robust performance of the oil palm


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crop and oil palm prices were important contributors to the success of the oil palm projects, thepoorer results of the non-oil palm projects were also due to their not being part of a well-plannedlong-term development.

62. The cocoa/coconut project confronted a major risk which was not adequatelydealt with under the single project development approach. The area selected for this project wasassessed as only moderately suitable for cocoa, based on broad soil and climatic data. Giventhe risk implied by this combination of data reliability and suitability classification, a pilot plantingof cocoa or more detailed site investigations prior to embarking upon a large-scale project wouldhave been preferable although the overall development would have taken longer. The cottondevelopment project provides a further example of the problems that can result from one-offdevelopments. In this project, the rapid expansion of the crop area outpaced the capacity of theextension service to adapt to an expanded role and develop appropriate operational proceduresand extension messages. This resulted in a rise in pest problems, low crop yields, and loss ofinterest in cotton by farmers. Expansion over a longer term with a succession of smallerprojects, or a project with a much longer disbursement period may have avoided such strain on

the extension services.

63. Generally, plans become defined only when an investment project is beingprepared and, even then, they are short term in nature, covering only the immediatedevelopment. Under these circumstances, the lending limitations such as minimum loan sizeand maximum disbursement period start to influence the plans. Thus, projects may beimplemented without adequate base information or pilot testing as occurred for thecocoa/coconut project, or projects may be overambitious as occurred for the cottondevelopment project. Longer term development planning requires a larger planning effort thanso far provided, underpinned by a greater sense of ownership over the development process by

the Government.

64. The ongoing PMU-type projects are also affected by the absence of long-termplanning, but from a different perspective. In these cases, short-term supports for the planting ofrubber, tea, and cashew have been provided under the projects, but longer term support forongoing technical advice, processing, and marketing have not yet been planned, and may notmaterialize in sufficient time or scale to meet the needs of the smallholder producers.

B. Implementation Approaches

65. The Banks projects have employed two basic implementation approaches, NESand PMU, with the latter replacing the NES approach in the late 1980s. Each approach hasstrengths and weaknesses and the experience to date can provide useful guidance for thedesign of future projects. The NES approach which was used only in the completed projectswas successful for oil palm but not very successful for other crops. The NES approach canwork, but the choice of crop or the presence of certain features is important. The suitability of oil


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palm is based on its attractive price, providing incentives for producers to achieve the targetedarea and yields. The relative prosperity for the smallholder beneficiaries which results from thisrobustness of the crop, coupled with a strong dependency of the producer on the processor fordisposal of the crop, have enabled the NES operator to recoup the costs of developing thesmallholder areas. Under this arrangement, all parties in the NES system have benefited. Theother crops tried under the Bank-supported NES projects, namely, cotton and cocoa, are not as

robust as oil palm and the link between producer and processor is not as strong as for oil palm.The sale of crop produce to outside traders has enabled the smallholder beneficiaries to avoidtheir repayment obligations to the detriment of the NES developer.

66. The cost of the NES approach as adopted under the Bank projects is relativelyexpensive, even for the oil palm schemes. Expressed in 1996 values, a NES scheme wouldcost over $7,000 per beneficiary and more than two dollars in investment cost are needed togenerate an income stream of one dollar per year for the beneficiaries. In comparison, the PMUapproach costs about $441 to $1,524 per beneficiary, and the same income stream of onedollar per year can be generated by project investments of as small as $0.68. However, the

absolute gains per beneficiary under the PMU-type projects are typically small, about 20 percentof those gained under the NES oil palm schemes, and it is harder to move beneficiaries abovethe poverty line under these projects than under a NES scheme. Moreover, the PMUarrangements, as currently designed, do not provide such comprehensive or long-termdevelopment arrangements as do the NES schemes. In the NES schemes, a long-termrelationship between processor and producer is established and the processor is interested inmaintaining smallholder production levels. This relationship is absent in the PMU projects wherethe focus is on crop establishment and these projects do not adequately provide for processingand marketing services, or for long-term technical support for smallholder producers. Thus, itmay be concluded that both the NES and PMU approaches are applicable for development, butthat further refinement of both is needed to make them effective.

C. Future NES Projects

67. The criticisms raised against the NES approach for oil palm development are thatit is relatively expensive per beneficiary, and does not address the problems of the manyfarmers with existing industrial crops. NES schemes could be formed around existingsmallholder areas and could also involve replanting some of the existing crops with oil palm. Inthese areas, the development expenditure on infrastructure would be lower than in newlyopened up areas. The area developed per beneficiary under the project could also be reducedso as to limit the cost per beneficiary. Other approaches could be used to assist smallholders to

expand their areas of particular crops such as oil palm. In view of oil palms profitability, it shouldalso be possible to encourage the private sector to undertake more NES oil palm projects,relieving the Government of part of the financial burden of development.

68. There are three main disincentives to private investment in oil palm NESprojects. First, some areas, including many in eastern Indonesia, lack basic infrastructure suchas roads and port facilities. The concentration of private oil palm development in Sumatra is


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partly a response to the better infrastructure there. Second, a Government-controlled formulafixes the price that both private and Government corporation oil palm mills must pay smallholderproducers for oil palm fruit, i.e., the FFB. The current parameters used in this formula areweighted in favor of the smallholder producer. As a result, private investors would prefer arelatively large nucleus estate and reduced smallholder area which is contrary to thedevelopment objective of Government which prefers to maximize the area occupied by

smallholders in new NES schemes. Obviously, the formula must provide a balance betweendevelopment objectives and what is perceived as an incentive by the private sector. Third, thecosts of borrowed funds are relatively high in Indonesia. There are only a small number ofprivate estate companies capable of undertaking such large investments as a NES project.Many potential investors, currently engaged in other sectors do exist. However, these investorsview agriculture as risky and seek lower cost funds to offset the higher risk perceived.

V. CONCLUSIONS

A. Overall Assessment

69. Seven of the 11 completed Bank-funded projects were based on oil palm. Theseprojects have been generally successful; the area targets have been met, the crop yields andfactory productivity are satisfactory and sustainable, and the projects have positively contributedto the national goals of poverty reduction, foreign exchange earnings, food self-sufficiency andeconomic growth. Their negative impact on the physical environment is minor. The projectswere geographically concentrated yet covered a long-time span, and evolved by progressively

building upon established strengths of knowledge and implementing capability. The projectachievements, coupled with important advances in deregulation as a result of studiesundertaken under Bank-assisted TAs, have had significant effects beyond the bounds of theindividual projects by stimulating private investment in parts of Sumatra. In a large part, thesuccess achieved with oil palm has been due to the crops competitive advantages. The yieldshave been consistently good and prices for oil palm have long been attractive. Altogether, theuse of the NES approach, the scale of the combined projects, their concentration in specificlocations and with the same implementing agency, the sequential risk minimizing approach andthe complementary Bank TAs, constitute a sound long-term oil palm development program.Important criticisms of the program, however, are the high public cost per beneficiary of the NESapproach and the focus on new land development as opposed to the improvement of existingfarmland.

70. The successes with oil palm were not repeated in the completed Bank projectsinvolving cotton and cocoa/coconut. Under the cotton and cocoa/coconut projects, profit waslow compared with oil palm, and the projected area targets were not met. The cocoa crop alsohas been infested with pod borer which further reduces profitability by lowering yields and cropquality. These projects were developed using the NES approach, but the smallholder producersof cotton and cocoa, like rubber producers, can easily sell their output to non-project traders,


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thus avoiding repayments to the project developers. Since the PTPs assume the responsibilityfor the development of the smallholder areas, non-repayment by the smallholder beneficiaries inthe cotton and cocoa/coconut projects have placed large financial burdens on these entities.Overall, neither the smallholders nor the NES developers have benefited greatly from thecocoa/coconut and cotton projects. Moreover, these projects appear as ad-hoc developments,not forming part of long-term development programs for either the areas or crops involved.

71. The Banks ongoing projects have attempted to spread development over aswide an area as possible by adopting the PMU approach which has a low cost per beneficiarycompared with the earlier NES schemes. However, the PMU projects do not include oil palm,but focus on crops such as rubber, cashew, and tea which have lower potential than oil palm forraising farm incomes. Compared with the estate schemes, new plantings under the PMUapproach also suffer from lower quality of tree establishment and maintenance, typical ofsmallholder development, while effective long-term arrangements for the continued support ofthe beneficiaries are more difficult to establish (see para. 34). Altogether, the output and incomeexpectations per beneficiary under the ongoing projects would be modest.

B. Lessons Learned

72. The NES projects can reduce poverty and generate national economic benefits.The experience so far suggests that a successful outcome requires (i) strong profitability of thecore productive unit or crop; (ii) adequate capacity and capability of the nucleus estate and/ormill operator to implement and operate the scheme; and (iii) a strong interdependence, forexample, through product processing, between the nucleus estate (and/or mill operator) and thesmallholders to facilitate credit recovery. For the completed Bank projects, these conditions

were achieved only for the oil palm projects.

73. Underutilization of the food crop areas is a problem in many existing NESprojects. These areas constitute a wasted resource. There is a need to review the policy on landallocations for food crop areas in new projects. An alternative would be to provide each settlerlarger house garden areas and incorporate the food crop areas as part of the tree crop area soas to accommodate additional settlers.

74. Smallholders do not generally adopt high input, high output production systems.Even in the NES oil palm projects which provide a relatively assured and high income, thesmallholder producers use lower than recommended amounts of fertilizer and adopt relativelylow management standards. This is not to say that low input, low output systems cannotproduce good returns, but that an appropriate balance must be achieved between the expectedoutput and the investment. Project preparation and appraisal studies should give particularattention to this issue in the design of smallholder components, and should use conservativeassumptions about farmer responses and the yields that are to be expected. This will help avoidarrangements where smallholders will have difficulty in repaying credit packages.


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75. In addition to the use of conservative yield assumptions during appraisal,appropriate risk analysis is needed. In the case of cotton, pests are always a potential problemwhile for the cocoa/coconut project, concerns were raised about the suitability of the area duringproject preparation. Evaluation of the effects of different assumptions for these factors on

project viability may have led to alternative development proposals.

76. The matching of processing capacity with actual crop outputs has not beenadequately achieved to date in the Bank-assisted projects. This appears related to the use ofoveroptimistic assumptions regarding yields and the need to establish all of the processingcapacity under the Bank loan. Underachievement of area targets also has contributed to theunderutilization of processing capacity. In the case of the rubber factories in North Sumatrasupported by the Bank, the regional development projections proved wrong. All of these casespoint to the need for more detailed analysis at the time of appraisal, and exploration of ways offunding a more progressive buildup of processing capacity.

77. Project implementation targets need to be defined in terms of the developmentpurpose, rather than simply in terms of physical achievements. Achievement of the latter maynot necessarily lead to the project objectives. For example, the focus on crop cultivation targetsfor the cotton project was not consistent with the objective of raising farm income. Thepreparation of project frameworks during project identification and their subsequent refinementduring project preparation and appraisal will help in this regard. By clarifying the relationshipsbetween goals and project inputs, and identifying the risks and means to monitor the program,this tool should facilitate flexibility during project implementation to enable inputs and outputs tobe modified in line with changed circumstances.

78. There do not appear to be any significant and widespread price incentives forsmallholders to produce higher quality in industrial crops such as cocoa and rubber.Smallholders can obtain similar incomes whether they smoke dry their rubber or sell it in lowquality lump form, and sun-dried cocoa beans earn just about as much as fermented beans andrequire much less effort on the part of the producer. Given this situation, efforts to improvesmallholder incomes through improvements in the quality of crop outputs will be difficult andproject proposals built upon improving product quality will require detailed assessment of thecommercial operations of produce traders.

C. Follow-up Actions

1. For the Government


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79. The oil palm projects could be improved. The Government could address thefollowing aspects:

(i) All of the oil palm and rubber processing facilities operate below capacity. Thepossibility of expanding smallholder areas to use this available capacity should be

explored. Greater flexibility for the PTPs in adjusting prices and payment terms forsmallholder output in areas where private mill operators offer competition or wherehigher prices could encourage greater smallholder productivity also would beadvantageous.

(ii) The oil palm mills can achieve higher extraction rates and lower their losses. Themore obvious areas for improvement include overall plant management, and theoperation of the decanters, kernel recovery units, and sterilizers. A system of auditto monitor mill efficiency and losses on a regular six-monthly basis such as is doneby private companies in Malaysia could be considered.

(iii) Fertilizer use in both the smallholder and nucleus estates is below optimum, more

so for the smallholders. Future yield declines are highly probable. A leaf analysislaboratory has been established under one of the Bank projects and is used.However, a larger number of samples for analysis are required, and the data hasto be interpreted in the context of price expectations and profitability under variouslevels of fertilizer application. The latter is not done at present. Moreover, most ofthe oil palm is fertilized with urea which is not as suitable as other forms of nitrogensince it volatilizes too quickly allowing the nutrients to escape.

80. Government ought to review the interprovincial quarantine system with a view torestricting the spread of the debilitating cocoa pod borer. This may be taken up under theongoing Bank-assisted Integrated Pest Management for Smallholder Estate Crops Projectwhich has a component for strengthening the countrys 37 plant quarantine stations. However,

effective quarantine for this pest may only be practical for some of the more isolated provinces,e.g., Irian Jaya, where the cocoa borer problem does not exist. The comparative advantage ofcocoa in Irian Jaya without the cocoa pod borer would be large and may justify a significanteffort to provide a quarantine barrier.

2. For the Bank

81. The Bank should review its approach to further development of the industrialcrops and agro-industry sector in Indonesia. It is important to strengthen the Governments

capability for medium to long-term sector planning. Such planning would identify the sequentialsteps for low risk development of particular areas or communities, as well as the investmentrequirements and sources of financing. In addition, the NES and PMU models used so far forthe sectors development could be reviewed to identify ways by which each could overcome itsweaknesses.


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BANK ASSISTANCE TO THE INDUSTRIAL CROP

AND AGRO-INDUSTRY SECTOR IN INDONESIA

AS OF 30 JUNE 1997

Table 1: Loans

Loan Amount Approval

No. Project Title ($ million) Date

A. Special Funds

0015 Sawit Sebarang Oil Palm Estate 2.40 Oct-69

0063 North Sumatra Rubber and Oil Palm 7.41 Mar-71

0148 East Java Sugar 11.29 Nov-73

1184 Upland Farmer Development 30.00 Nov-92

1258 Sustainab

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