What Direction for Price Control.

What Direction for Price Control. [Posted 20 Aug 2015, 164 views, 10 likes, o comments].

The Jakarta Post (18 Aug15) on “Jokowi toying with price controls” is a neat introduction to the most recent phase of Indonesia’s long history to manipulate a free trade system. Most governments and big industry players also look to manipulate free trade for their benefit.

Cheaper Products.

The Jakarta Post article focused on the governments control over State Owned Enterprises (SOE’s) to lower the price of cement, temporary reduce toll fees, and increase Pertamina’s losses through reintroducing subsidized fuel. The Government is the controlling shareholder in SOE’s and this price control trend to provide cheaper products is a form of stimulus for national growth. This price control strategy is probably more effective than keeping product prices high and then redirecting the SOE’s profits to government poverty or growth programs. The Government has recently indicated it is willing to invest further capital into some SOE’s, but the Government has also made it clear a number of SOE’s (including PLN) are to seek funds from the private sector for their growth. Unfortunately it is likely the SOE’s may not be able to borrow at reasonable rates from commercial sources to undertake growth, as the risk to the investor is that the SOE’s are no longer subject to the economics of free trade, but have an increased business risk – that at any point the Government can reduce the SOE’s profit projection for political reasons.

For years the Indonesian government has kept the price of rice at a low level, and actively manipulates other aspects of the food market, all in an effort to keep food affordable for the poorer Indonesians, and to keep national inflation index low. This is great for the urban poor, but the low prices also makes a poverty trap for the rice farmers. Similarly the government sets the price of travel (toll roads, rail, air travel) to keep travel affordable to most Indonesians, but limits the development and performance of such SOE’s as PT. Kreta Api. We see government calls for high speed rail between Jakarta and Bandung are dependent upon significant investment by China or Japan (that will factor in an element of profits to such countries), rather than organic growth by PT. Kreta Api.

Financially weak SOE’s may be more susceptible to occasional business shocks. For example if a earthquake were to substantially damage the toll roads or rail network, then the government may find it doubly difficult to fund the reconstruction, through possible lack of funds plus the downturn in growth due to the disrupted transport system. Pertamina may be reviewing the risks of taking over the Mahakam oil block wherein it needs significant operating capital to maintain production, but the Government wants cheap fuel delivered to the public. Similarly the poor rice farmers are at greater risk from drought or pests etc.

More Costly Products.

Other Jakarta Post news refers to government price controls through making higher import tariffs to protect more costly local products was recently seen with the steel imports to protect the SOE of Krakatoa Steel. The government also uses a number of other means such as import quotas (beef, sugar) to distort free trade. Such trade impositions should be seen as a temporary measure to give short term relief to local producers. However, if such protection is prolonged, it can lead inefficiency and poor business practices and entrenched high production costs. These higher costs to the public may contribute to slow national growth and increase for inflation, which means such items are less available to the poorer Indonesian population.

Price Control Failures – The recent attempt to promote the Indonesian cattle industry was made by restricting imported beef to drive up the price of meat that was hoped to stimulate the national cattle herd and lead to self sufficiency of beef. However the opposite happened, wherein the Indonesian farmers took this opportunity to sell at such a high market price, and thereby seriously diminished the Indonesian cattle population. This was not a win-win, but a loss-loss situation with the people enduring higher beef prices (increased national inflation) and a deteriation of the national cattle industry.

Another example of attempting to manipulate prices is seen with PT. Timah restricting sales of finished tin, in an effort to create a diminished supply to international markets. This price control strategy is to drive up the price of tin and thereby increase royalties and taxes for Indonesia. There is no clear indication that such a strategy is working, and an unintended consequence is that the illegal tin trade has apparently increased (with corresponding lack of royalty & taxes), thereby depriving Indonesia from any perceived additional margin from the targeted higher price of tin.

Where are Price Controls for the Smelting Industry Going?

We saw with the aluminum plant in Sumatra had a long term supply contract with discounted prices for the Japanese development partner, as a part of the package with the SOE to attract the initial investment. This was good business for both Indonesia and the investor. However it is likely there are no such pricing assurances for many of the new generation of private smelter investors. My fear is that this government tendency to meddle with commodity price controls will extend to the mineral smelting industry. The government has already indicated it will want the smelters to supply the domestic market as priority over the international market. The government has placed a significant export tax on raw minerals, and has not promised that finished smelted products will be free of similar excessive export fees. The price control of domestic and export of smelter products must be a concern for the mining industry and there is no guarantee the prices and reliability of delivery to Indonesians will be competitive to imported products.