Interest rates and export taxes on CPO export

General Business Environment

(Monetary and Fiscal Policies)

THE INFLUENCES OF BI RATES

AND EXPORT TAXES

ON INDONESIAN PALM OIL INDUSTRY

Prof. Wihana Kirana Jaya, M.Soc.Sc., Ph.D.

by:

Nanang Suko Sadono

13/361118/PEK/19272

Batch 63 International

MAGISTER OF MANAGEMENT

UNIVERSITAS GADJAH MADA

YOGYAKARTA

2014

THE INFLUENCES OF BI RATES

AND EXPORT TAXES

ON INDONESIAN PALM OIL INDUSTRY

1. INTRODUCTION

Indonesia is the biggest producer of Crude Palm Oil (CPO) in the world which

produced more than 25 million tons in 2012 and more than 200 trillion rupiahs in foreign

exchange. The development of this industry, therefore, is important for the development of

economy in Indonesia, as one tool to deal with problems faced such as poverty. This

industry is also crucial in supporting the government in anticipating crisis of energy in the

future due to the decreasing number of gas and oil over time.

The increasing needs of renewable energy as the substitute of petroleum has also

driven the demand of pam oil in international market. This high demand has led the price of

palm oil in international market become higher. The high international price then persuade

domestic producers to market their products to other countries, and this is a logic

consequence since the companies as business entities always want to maximize their profit.

The problem arise when all companies are forgetting the domestic market. Cooking

oil, which is the end product of CPO, can be said as one of the most important goods in the

market. Since the international price is more attractive than the domestic one, many

producers of palm oil put more attention on their export rather than their distribution to

domestic market. In order to deal with this problem, Indonesian government, like many other

governments, imposes export tax on CPO. By imposing export tax, particularly for CPO, the

government hopes that the companies become more willing to process CPO become

cooking oil and sell it in domestic markets rather than maximizing their export of CPO.

Apart from the export tax on CPO, which can be categorized as a fiscal policy, the

export of palm oil might also be influenced by interest rate stated by Indonesian Central

Bank (BI rate), though the relationship among them are still debatable

This paper is trying to look closer on these three variables, export tax, BI rate, and

the export of CPO from Indonesian companies. By analyzing the relationship among those

variables, we may understand the effectiveness of the policies have been done by the

government (imposing export tax or maintaining the stability of interest rate) to regulate or

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control the export of CPO and in the same time encourage the palm oil companies to put

more attention on producing end products of CPO rather than exporting CPO.

2. Theory of Monetary and Fiscal

Monetary Policy

Monetary economics investigates the relationship between real economic variables

at the aggregate level (such as real output, real rates of interest, employment, and real

exchange rates) and nominal variables (such as the inflation rate, nominal interest rates,

nominal exchange rates, and the supply of money) (Walsh 2010). However, it slightly differs

from macroeconomics since it focuses more on price level determination, inflation, and the

role of monetary policy. The last focus, about the monetary policy, involves the government’s

actions to control money supply available in the market by its ability in creating or absorbing

money.

In Indonesia, the goal of monetary policy is stated specifically, that is to achieve and

maintain the stability of the rupiah. Rupiah stability is defined, among others, as stability of

prices for goods and services reflected in inflation. In other words, maintaining the inflation is

critical in monetary policy since by stabilization of inflation (stabilization of rupiah as well),

would result in the stability of prices of goods and services. To carry this out, Bank Indonesia

holds powers to conduct monetary policy through the establishment of monetary targets

(such as money supply or interest rates) with the primary goal of keeping inflation at the

government-prescribed level (www.bi.go.id).

Furthermore, to implement monetary policy, Bank Indonesia has opted for a working

framework known as the Inflation Targeting Framework (ITF). Under this framework, Bank

Indonesia explicitly announces the government-set inflation target to the public and

monetary policy is geared towards achievement of this target. For the inflation target to be

reached, monetary policy is implemented with a forward-looking approach, meaning that any

change in the monetary policy stance is undertaken after evaluating whether future

developments in inflation are on track with the established inflation target. Under this

framework, monetary policy also operates with transparency and accountability to the public.

At the operational level, the monetary policy stance is reflected in the setting of the policy

rate (BI Rate) with the expectation of influencing money market rates and in turn the deposit

rates and lending rates in the banking system. Changes in these rates will ultimately

influence output and inflation (www.bi.go.id).

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Interest Rate Policy

Interest rate is basically the amount charged, expressed as a percentage of principal,

by a lender to a borrower for the use of assets. Interest rates are typically noted on an

annual basis, known as the annual percentage rate (APR). The assets borrowed could

include, cash, consumer goods, large assets, such as a vehicle or building. Interest is

essentially a rental, or leasing charge to the borrower, for the asset’s use.

In public sector, the definition of interest rate is also the same. Here, in the field of

monetary policy, the interest rates are usually used by the central bank (Bank Indonesia) to

shape monetary policy. This interest rate is the rate at which banks can borrow money from

the central bank.

Generally, there are two types of interest rates, nominal and real interest rates.

Nominal interest rate is the interest rate that takes all these risks and the time value of

money into account (Kudlacek 2010). This rate does not correct for changes in purchasing

power. The nominal interest rate is the one that is quoted in e.g. newspapers. Deducting the

premium for the inflation risk, results in the real interest rate. The real interest rate describes

the relative price between consumption today and consumption in the future.

Another categorization of interest rates can be seen by the length of period. In this

classification, interest rates can be divided into two types, short term interest rates and long

term interest rates. The first mentioned, are determined by the central bank of the country

with the purpose of maintaining the money supply or inflation. Long term interest rates, on

the other hand, are determined by the market.

Long term interest rates tend to follow the business cycle. When a boom is expected,

the expectations of higher inflation lead to higher long term interest rates. At the top of a

boom when the market begins to weaken, the long interest rates are adjusted downwards.

Short term interest rates on the other hand are more volatile and do not follow the business

cycle as strictly. The central banks tend to keep their key interest rate at a high level even

after a top of a boom, since the threat of higher inflation can persist. After a recession the

interest rate of the central bank tends to stay at low levels (Kudlacek 2010).

Fiscal Policy

The term “fiscal” comes from a Latin word “fiscalis” which in turn comes from “fiscus”,

that has a meaning “a basket used for collecting money” (Tanzi 2004). Therefore, fiscal

policy can be said as policy related to collecting money from people (taxes). In the

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development, the Keynesian revolution has changed the meaning of fiscal policy. According

to the Keynesian, fiscal policy is not only focused on revenue dimension (collecting taxes

from people), but also on spending and it has a purpose to influence overall demands in the

market. In other words, fiscal policy is the manipulation of taxes and public spending to

influence aggregate demand. There are three main purpose of fiscal policy that are

proposed by Musgrave (1959) and Johansen (1961), two influencing economist in fiscal

policy theories (Tanzi 2004):

stabilization;

income redistribution;

resource reallocation.

Export Tax as One of Fiscal Policy

In most countries, fiscal policy decisions, particularly in relation to international trade,

are usually aimed at increasing exports together with decreasing imports. To do implement

such decisions, many governments usually implement import taxes and export subsidies. By

imposing import taxes, the governments want to protect their domestic industries from the

penetration of their foreign competitors. Moreover, in many countries, import taxes are

important elements in their budget systems since these taxes are sources of national

revenues. Export subsidies, in other hand, focus on the international market of the products

from domestic companies. These policies are implemented in order to increase the

competitiveness of domestic producers so that they manage to compete with other

companies in international level.

Export taxes, therefore, are actually the opposite of export subsidies. While the

purpose of export subsidies is to improve the amount of goods being exported, the purpose

of export taxes is to reduce or control them. Economic analysis provides several rational

justifications for implementing export taxes in international trade (Bouet and Debucquet

2010):

1) Terms-of-trade justification. This is perhaps the most important justification. By

restricting its exports through export taxes, a country that supplies a significant share

of the world market in a commodity can raise the world price of that commodity. This

implies an improvement in that country’s terms of trade.

2) Food security and final consumption price. By creating a wedge between the world

price and the domestic price, a government can lower the domestic price by

reorienting domestic supply toward the domestic market.

3) Intermediate consumption price. Export taxes on primary commodities (especially

unprocessed ones) work as an indirect subsidy to higher-value-added manufacturing

or processing industries by lowering the domestic price of inputs compared to their

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world non-distorted price. While the previous justification addresses the use of export

taxes to lower price for final consumption, this one is concerned with decreasing

prices for intermediate consumption.

4) Public receipts. Export taxes provide revenues to developing countries with limited

capacity to rely on domestic taxation.

5) Income redistribution. Like import tariffs, export taxes are measures that imply

redistribution of income to the detriment of domestic producers of the commodity

taxed and to the benefit of domestic consumers and public revenues.

6) Stabilization of domestic prices. In order to stabilize domestic prices for export

producers, some developing countries use variable tax rates. Piermartini (2004)

provides the example of Papua New Guinea, which established an export tax /

subsidy rate for cocoa, coffee, copra, and palm oil equal to one-half the difference

between the reference price—calculated as the average of the world price in the

previous 10 years—and the actual price for the year.

In Indonesia, and also in most countries, there are three bases in calculating export

taxes (PP no.55 2008):

fixed per-unit levies, or

ad valorem duties.

In fixed per-unit levies, the export taxes are determined in some amount of money

per quantity, while in the ad valorem, the taxes are determined using percentage of the price

of goods being exported.

3. VARIABLES

In this paper, the influences of monetary and fiscal policies are analyzed in order to

examine their influence on Indonesian palm oil industry. The variable in monetary policy that

is used is the interest rates. The interest rates that are included in the model is the monthly

BI rate issued/announced by Indonesian Central Bank (Bank Indonesia).

In fiscal policy, the export taxes are being used in the analysis. The export taxes here

mean the export taxes imposed by Indonesian government on palm oil that is being exported

to other countries. The data about export taxes on palm oil are from the regulation issued by

the Ministry of Finance. Finally, those two variables (BI rates and export taxes) are being

examined together with the last variable that is the export volume of palm oil from Indonesia

to other countries worldwide. Palm oil product that is being analyzed here is only the CPO

(Crude Palm Oil) in order to get clearer and better understanding about the relationship

among all variables. Moreover, the CPO accounts for the biggest portion of palm oil products

that are exported from Indonesian companies.

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Independent Variables:

BI rates : the interest rates that are announced by the Board of Governors of Bank

Indonesia in each monthly reflecting the monetary policy stance adopted by

Bank Indonesia.

Export Taxes : the taxes that imposed by Indonesian government on Crude Palm Oil that is

being exported to other countries.

Dependent Variable:

Export of CPO: the amount of Crude Palm Oil that are exported to other countries every

month.

4. HYPOTHESIS

This study proposes three hypothesis. The first hypothesis is proposed to test the

relationship between all independent variables (BI rates and export taxes) and dependent

variable (export of CPO) simultaneously. The other two hypothesis are used to test the