Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 18125

IMPLEMENTATION COMPLETION REPORT

INDONESIA

FERTILIZER SECTOR RESTRUCTURING PROJECT

(LOAN 3282-IND)

June 29 1998

Private Sector Development UnitEast Asia and Pacific Regional Office

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit = Indonesia Rupiah (Rp)Appraisal Report US$1 Rp 1,830ICR (Dec 1997) US$1 =Rp 5,000

FISCAL YEAR

April 1 - March 31

WEIGHTS AND MEASURES

Metric System

ABBREVIATIONS AND ACRONYMS

AS - Ammonium SulfateEkku Wasbang - Coordinating Ministry for Economic, Finance and Development

SupervisionFSP - Fertilizer Sector PoliciesGresik - PT Petrokimia Gresik, GresikICR - Implementation Completion ReportKaltim - PT Pupuk Kalimantan Timur, BontangKujang - PT Pupuk Kujang, CikampekMOA - Ministry of AgricultureMOIT - Ministry of Industry and TradePFC - Participating Fertilizer CompanyPIM - PT Pupuk Iskandar Muda, AcehPusri - PT Pupuk Sriwijaya, PalembangSAR - Staff Appraisal Reporttpd - Tons per Daytpy - Tons per YearTSP - Triple Superphosphate

Vice President Jean-Michel Severino, EAPVPCountry Director Dennis N. de Tray, EACIFSector Manager Hoon Mok Chung, EASPSTask Manager Kunrat Wirasubrata, Operations Officer, EACIF

FOR OFFICIAL USE ONLY

CONTENTS

PREFACE . iii

EVALUATION SUMMARY. v

PART I: PROJECT IMPLEMENTATION ASSESSMENT ...............................................IA. Project Objectives and Description ........................................................ 1B. Achievement of Project Objectives ........................................................ 2C. Implementation Record and Major Factors Affecting the Project ...........................6D. Project Sustainability ........................................................ 6E. Bank Performance ................... 7F. Borrower Performance ........................................................ 7G. Assessment of Outcome ............. ...................................... 8H. Future Operations ........................................................ 81. Key Lessons Learned ........................................................ 8

PART II: STATISTICAL TABLES ....................................................... 10Table 1: Summary of Assessments ............................................. 10Table 2: Related Bank Loans/Credits . 1Table 3: Project Timetable. I ITable 4: Loan/Credit Disbursement: Cumulative Estimated and Actual . 1'Table 5: Key Indicators for Project Implementation .12Table 6: Key Indicators For Project Operations .12Table 7: Studies included in Project .13Table 8a: Project Costs ............................................ 13Table 8b: Project Financing ............................................ 13Table 9: Economic Costs and Benefits ...................................................,,.,,.,. 14Table 10: Status of Legal Covenants .................................................. 14Table 11: Compliance with Operational Manual Statements ................................... 15Table 12: Bank Resources: Staff Inputs .................................................. 15Table 13: Bank Resources: Missions .................. ................................ 16

ANNEX A: ICR MISSION'S AIDE MEMOIRE .................................................. 17

ANNEX B: BORROWER'S COMMENTS ON THE ICR ................................................ 27

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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IMPLEMENTATION COMPLETION REPORT

INDONESIA

FERTILIZER RESTRUCTURING PROJECT

(LOAN 3282-IND)

PREFACE

This is the Implementation Completion Report (ICR) for the FertilizerRestructuring Project in Indonesia, for which Loan 3282-IND in the amount of US$221.7million equivalent was approved on December 20, 1990 and made effective on March 26,1991.

The loan was closed on December 31, 1997. Final disbursement took place onOctober 8, 1997. A balance of US$6,526,911 was canceled as of December 31, 1997.

The ICR was prepared by Kunrat Wirasubrata (Operations Officer/Task TeamLeader, EACIF), with contributions from Kurt M. Constant (Senior Industrial Specialist,IENIM), Thomas Walton (Senior Environment Specialist, EACIF) and UnggulSuprayitno (Financial Analyst, EACIF). Hoon Mok Chung, Sector Manager, PrivateSector Development Unit, EAP reviewed the report.

Preparation of this ICR, which began during the Bank's final supervision missionin October 1997, was based on materials in the project file. The Government commentedon the draft but did not prepare a separate evaluation.

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INDONESIA

FERTILIZER RESTRUCTURING PROJECT

(LOAN 3282-IND)

EVALUATION SUMMARY

Introduction

1. The Fertilizer Sector Restructuring Project (the Project), for which thisImplementation Completion Report (ICR) is prepared, was designed based on the Bank'sfertilizer sector work in 1988. This is the last in a series of Bank-supported projects in theIndonesian fertilizer sector that began in 1970.

2. The fertilizer industry in Indonesia is characterized by highly administered feedstock and product prices, an inefficient distribution system and excessive end-userconsumption, which had led to the industry's potential being not optimally cultivated. Toaddress this issue, the Government had in 1990 produced a Statement of Fertilizer SectorPolicies aiming at improved sector efficiency and performance.

Project Objectives

3. The Project's objectives were: (a) to assist the Government in implementing theStatement of Fertilizer Sector Policies (FSPs), which focused on adjustment of fertilizerprices to reflect their economic prices, leading to gradual elimination of the associatedsubsidy payments from the government budget; (b) identify the scope for improvedefficiency in marketing and distribution; (c) assess the industry's environmental impactand standards, and prepare an environmental management program; and (d) support anindustry-wide investment program.

4. With the first objective, the Government was responding to the need forsustainable sector restructuring to improve overall efficiency of the industry. With thesecond objective, the Government sought to identify options and scope to improveefficiency of fertilizer distribution. The remaining two objectives were necessary toimprove technical efficiency and productivity of Indonesian fertilizer sector as well asincrease production capacity. Five of six state-owned fertilizer companies (PT PupukIskandar Muda, PT Pusri. PT Pupuk Kujang, PT Petrokimia Gresik, and PT PupukKalimantan Timur) participated in the Project. PT ASEAN Aceh fertilizer, owned by theASEAN countries, did not participate.

Implementation Experience and Results

5. Fertilizer Sector Policies. The Government has partially adjusted the price of gasinputs and regularly adjusts that of urea. Price control on phosphate and ammonium

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sulfate fertilizers has also been removed completely. These have resulted in significantreduction of budgetary subsidy by almost 60 percent from Rp 457 billion in FY92/93 toRp 195 billion in FY96/97'.

6. Limited improvements made in the marketing and distribution system have notfully realized the potential gain if the system is fully restructured. The Government'sreluctance to restructure is due to its desire to make fertilizer products availablethroughout the country at uniform prices. Ironically, despite the efforts to enhanceup-stream and distribution efficiencies, farmers continue to apply fertilizer excessively. Astudy commissioned under the project indicated excess fertilizer application in Java to bein the range of 20 to 30 percent. Also, the Ministry of Agriculture (MOA) prepared afertilizer demand projection, which determines annual production volume, that continuesto be historically based by applying a certain percentage of annual increase rather thanbased on systematic individual soil analyses.

7. Despite these accomplishments, as the adjustments continue to be initiated andadministered by the Government, the sector remains heavily regulated with its structuralinefficiencies. Furthermore, the FSP had failed to address more fundamental issues suchas introduction of competition within the sector and full sector deregulation. Viewed fromthis perspective, the FSP was inadequately designed to result in improved overalleconomic efficiency.

8. Industry-wide Investment and Environmental Program. All objectives relatedto the industry-wide investment program and application of environmental standards havebeen satisfactorily achieved. A new ammonia and urea plant in Gresik, adding about460,000 tons per year (tpy) of urea to the country's production capacity, has beenon-stream since 1994 and modernization of Gresik's phosphate fertilizer plants werecompleted in 1996 with satisfactory results. Energy consumption per ton of ammonia/urea produced in five optimized plants has been reduced, environmental standards for thefertilizer industry have been established, and an effective environmental managementprogram is already in place in all participating fertilizer companies. The long experienceof the participating fertilizer companies (PFCs) in constructing and operatingammonia/urea plants is a factor critical to the successful implementation of theinvestment program. However, the project's rates of return are lower than appraisalestimates due to lower export prices and assumed higher price of gas input(US$2/mmbtu). Lower export prices also has led to unfavorable financial condition of thePFCs.

9. Implementation Experience. Except for international fertilizer prices, all otherfactors necessary to warrant a successful implementation were basically within thecontrol of the Government. This is shown by the satisfactory implementation of the

However. draftic devaluation of the Rupiah against the USR has dramatically increased production cost andforced the Government to re-introduce subsidy for these products (SP36 and AS) in April 1998.

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physical investment program. In implementing the FSP, however, its broad institutionalimplication appears to have been inadequately addressed, as indicated by the absence of astrong leadership agency to provide and direct formulation and implementation of thepolicies. Toward the end of implementation, this shortcoming appears to have beenaddressed through establishment of a Holding company, chaired by PT Pusri, with amandate to further improve sector efficiency, set the stage for privatization of the PFCs,and prepare the sector for full deregulation in early 2000s. Although it is not necessarilythe ideal solution, if it has full support from the Government, is professionally managed,and is consistently directed toward realizing overall sector efficiency, the Holding has thepotential to bring its mandate into reality. Pusri Holding was formed on August 7, 1997,comprising PT. Pusri as holding and PT Pupuk Kaltim, PT Petrokimia Gresik, PT Kujangand PT Pupuk Iskandar Muda respectively as subsidiaries. The main goal of the holdingamong others are: to improve national productivity and efficiency as well ascompetitiveness and to gain the synergy effect in the future business development.However, the formation of Pusri holding raises questions on the ability to efficientlyrestructure and privatize the individual fertilizer centers

10. Overall, through the project, the Bank has made a positive contribution to thedevelopment of a technically efficient fertilizer industry comparable to world standards.Within the limitation of the Project's stated objectives, both the Bank's and theBorrower's performance in the various stages of the project cycle have been satisfactory.However, since a large part of the FSP is still to be implemented after project completion,project outcome is satisfactory only in terms of physical achievement and unsatisfactoryin terms of solving the more fundamental policy issues of the fertilizer sector. From theproject's point of view, sustainability of its accomplishments is uncertain, and from thecountry's perspective, Indonesia's plan to change its fertilizer industry into be a highlycompetitive and economically efficient remains an unfinished agenda.

Summary of Findings, Future Operations, and Key Lessons Learned

11. Three important lessons can be drawn from the project, as follows:

* Well-defined policy measures including quantitative targets and timetables shouldhave been agreed with the Government in the design stage. Implementation of thefertilizer policy statement should have addressed more fundamental issues such as fullsector deregulation, competition development, and privatization.

. Coordination (or the lack of it), while being a classic issue, continues to be animportant ingredient for policy implementation in a multiagency environment. In thiscontext, a strong lead agency should have been agreed upon and appointed early inthe design stage.

* Strong technical capability, as shown by the PFCs, is of utmost importance in theimplementation of an industry restructuring project that involves adding newproduction capacities and enhancing plant efficiency and productivity.

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12. Finally, it is important to note that project achievements and future operations ofthe PFCs are at risk if the current regulatory regime is maintained. This is even more soas optimized plants in PIM, Pusri and Kujang continue to age and will ultimately needreplacement. Even under Holding management, short- and medium-term financialproblems faced by the companies are not likely to be solved internally and externalassistance, including private sector involvement, will have to be mobilized. This can beachieved in an efficient, competitive sector environment that is to be created through fullsector deregulation, privatization of PFCs, and enhanced private sector participation.

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INDONESIA

FERTILIZER RESTRUCTURING PROJECT

(LOAN 3282-IND)

PART I: PROJECT IMPLEMENTATION ASSESSMENT

A. PROJECT OBJECTIVES AND DESCRIPTION

1. The primary impacts the project was seeking were an improvement in efficiencyand performance of Indonesia's fertilizer industry, a reduction of budget subsidies, andminimization of adverse environmental impacts of fertilizer production. These impactswere to be achieved by accomplishing the following objectives: (a) to assist theGovernment in implementing an agreed Statement of Fertilizer Sector Policies (FSP)aiming at enhanced economic efficiency, improved distribution and marketing, andabating pollution; (b) to identify the scope for improved efficiency in marketing anddistribution; (c) to assess the industry's environmental impact and standards, and preparean environmental management program; and (d) to support an industry-wide investmentprogram. The objectives were responsive to the need of the Indonesian fertilizer sectorand no major modifications were made during project implementation.

2. Implementation of the FSP is the thrust of the project as it directly responded tothe needs of the industry to restructure the gas input and product pricing system and tointroduce competition in production and distribution so that overall industry efficiencycould be achieved. This was to be accomplished by gradually bringing the prices of gasinput and fertilizer products (both at factory and farm levels) to their respective economicprices, gradually eliminating budget subsidies and by reforming PT Pusri's distributionsystem.

3. To support FSP, two studies on fertilizer distribution and marketing and ondevelopment of environmental program management were commissioned by theDirectorate General of Chemical Industry of the Ministry of Industry and Trade (MOIT).The studies came up with recommendations, some of which were implemented duringproject implementation.

4. To respond to a projected increase in demand for nitrogen fertilizer, the projectsupported an industry-wide investment program and provided funds for capacityinvestment in PT Petrokimia Gresik. This included (a) building a new ammonia/ureaplant at Gresik, with a capacity of 1,350 tons per day (tpd) of ammonia and 1,400 tpd ofurea, to provide low-cost ammonia to existing operations and to reduce urea distributioncosts in East Java, including provision of engineering services and licenses therefor; and(b) supporting modernization investments in Gresik's existing fertilizer plants to increase

output of phosphoric acid and improve performance of the ammonium sulfate (AS)facilities and ameliorate environmental pollution.

5. Included in the industry-wide investment program was the optimization ofammonia/urea plants in PT Pupuk Iskandar Muda, PT Pusri, PT Pupuk Kujang, and PTPupuk Kalimantan Timur. The objectives of the optimization were to improve efficiencyof energy and raw material consumption, enhance output, and improve environmentalperformance of the plants.

6. The policies were spelled out in the Government's letter of November 10, 1990.These included plans to bring prices of gas input and fertilizer products (ex-factory andfarm-gate levels) to their respective economic prices, to gradually eliminate budgetarysubsidy, and to improve Pusri's distribution system.

B. ACHIEVEMENT OF PROJECT OBJECTIVES

Implementation of Fertilizer Sector Policies

7. Overall. Progress was observed during project implementation, includingabolition of price controls over phosphate fertilizers, and gradual, albeit partial,adjustment of gas input and urea prices to reflect their economic prices. Fiscal subsidieshave also been reduced by more than two-thirds. However, at the end of the project thesector remains dominated by the Government and its structure has not changed. Neitherare the participating fertilizer companies (PFCs) in encouraging financial condition andable to sustain project achievements from their internal resources.

8. Pricing Policy. Ex-factory and farm-gate prices of urea continue to be adjusted.Compared to those at the project's inception year (1990) the ex-factory price hasescalated by more than 170 percent and the farm-gate price by 190 percent. When thenew farm-gate price (Rp 400/kg)2 was announced in early 1997, with declininginternational prices and an exchange rate of Rp 2,200/US$1.00, the farmers werepractically buying urea at higher-than-international prices. With the currency crisisbeginning in June 1997 whereby the Rupiah lost more than 75 percent of its buyingpower against the dollar, fertilizer prices in Indonesia have become much lower than theirinternational prices in dollar terms.

9. In 1993 and 1994 the Government abolished price controls on potash, phosphate,and AS. Subsequently PK Gresik discontinued production of triple superphosphate (TSP)and replaced it by SP36 (superphosphate with 36 percent of P205). As a result, productioncosts have been reduced and subsidies for TSP and AS totally eliminated over the past

2 In April 1998. the Government raised the farm-gate price to Rp 450/kg. still very low in dollars terms Nvhen theexchange rate was Rp 8,500 to a dollar. This price level is considered to remain affordable to the farmers as theGovenment has also raised the price of rice.

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two years. Although not totally eliminated, overall budget subsidies have decreased fromRp 457 billion in FY 1992/3 to RP 195 billion in FY 1996/73.

10. The Government has partially adjusted gas prices. Under current plans and withthe expiration of old gas contracts (the original "Integrated Gas Purchasing Agreement"of 1975 covered a period of 20 years), gas prices are being increased individually plant-by-plant. The following gas price adjustment have been reported: US$1.85/mmbtu forPusri's plant numbers II, III and IV, US$1.50 for Pusri plant number I-B, for exportUS$1.85; PK Gresik US$2.00, for which US$1.00 will be reimbursed for domestic sales;and a special price formula (around US$1.60 to US$2.60) to be negotiated for newprojects. According to the Ministry of Industry and Trade (MOIT), deregulation of gasprice should be implemented around the year 2000.

11. The limited adjustment of gas prices is inadequate to guarantee a stable gas supplyfrom Pertamina. This is due to the growing number of competing gas users, private aswell as public, who are willing to pay more than US$1/mmbtu. Kujang, Pusri, and PIMhave in many instances experienced deteriorating gas supplies, which constrainedproduction at maximum capacity.

12. Although not totally eliminated, overall budget subsidies have decreased fromUS$457 million during FY1992/93 to US$195 million in FY1996/97. These accomplish-ments notwithstanding, the adjustments continue to be government administered and tendto be less responsive to market trends. At the end of project implementation the sectorremains heavily regulated with its inherent structural inefficiencies.

13. Marketing and Distribution. Despite clear evidence that substantial benefitsmay be obtained by restructuring the marketing and distribution system, the Governmenthas been reluctant to introduce major changes in view of its desire to keep uniformfertilizer prices throughout the country and to ensure reliable delivery. This has led toexcessive use of fertilizer products by farmers. There are indications that in certain partsof Indonesia, particularly in Java, agricultural output would not drop even if fertilizerapplication rates were reduced by 20 to 30 percent. However, most farmers are reluctantto reduce application rates out of a perception that less fertilizer may lead to less crop. Inthe meantime, the Ministry of Agriculture's (MOA's) annual fertilizer demand projection,which determines the volume of production, continues to use a more or less linearprojection model and only recently has started, on a pilot basis, to work on reviseddemand projections based on systematic individual soil analyses.

14. Development of intrasectoral competition, full sector deregulation, andprivatization were not articulated as formal policy options during FSP implementation.This led to a situation where efficiency enhancement measures affected only the public

3 See footnote 1.

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sector producers and its scope was confined to technical rather than overall economicefficiency with limited repercussion in the private sector.

15. In September 1997 the Government established a Holding company by fullytransferring its shareholding in each PFC to PT Pusri. The Holding, whose structure isstill emerging, will coordinate and consolidate marketing and plant operations with atarget of overall efficiency improvement in the fertilizer sector and subsequent pooling ofdomestic and international financial resources for future investments with private sectorparticipation. The ultimate goal is to achieve full sector deregulation in the early 2000sand privatization of the PFCs.

Environmental Management Program

16. In cooperation with BAPEDAL, MOIT has finalized and accepted waste wateremission standards in the fertilizer sector that are based predominantly on EC standards.Work on air pollution standards is progressing and should be completed. An appropriatemonitoring and enforcement plan has been prepared and three PFCs (Kujang, Pusri, andPIM) are participating in the scheme and achieved the "blue" rating (i.e., in compliance)in 1997. Kujang has been constantly in the "blue" since June 1995, when the first ratingswere given. Pusri has been "blue" since December 1995, and PIM achieved the "blue"status in October 1996.

17. For air quality, the program is just beginning as the standards will not be enacteduntil late 1997. Emissions monitoring, however has begun in conjunction with ISO 14000now adopted by the PFCs.

Industry-wide Investment Program

18. Overall. Indonesia has constructed and operated state-of-the-art fertilizer plantsand many of these are among best-run plants in the world. This strong backgroundfacilitated satisfactory implementation of the industry-wide investment program.However, with declining international prices and an assumed US$2/mmbtu gas price, thefive PFCs recorded lower-than-appraised rates of return. Consecutively, the Gresik rate ofreturn is calculated at 7 percent (Staff Appraisal Report-SAR-15 percent), Kujang 8percent (SAR 16 percent), Pusri 22 percent (SAR 32 percent), Kaltim 14 percent (SAR 32percent), and PIM 10 percent (SAR, NA). In spite of their optimized condition, plants inPusri, Kujang, and PIM have further aged and wear and tear in the plants have continued.The project has helped to compensate lower plant availability due to aging by higher andmore efficient capacity.

19. PT Petrokimia Gresik Restructuring. The new ammonia and urea plants havebeen placed in service since 1994 and modernization of PK Gresik's phosphoric acid andAS facilities has been completed and in operation since 1996. The new plants are nowfully operational, adding 460,000 tons of urea to the country's annual productioncapacity. Project completion was delayed about six months, mainly by the late arrival ofgas at the battery limit due to delay in completion of Pertamina's natural gas pipeline.This caused increased interest and supervision costs and loss of production.

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20. While energy efficiency of the new plants is in line with original expectations, theurea plant has not operated to its full potential due to scale deposits from the ammoniaplant, which was not resolved at the time of writing of the ICR. The total cost for thiscomponent was US$316.2 million (SAR estimate US$305.4 million), of which US$126.3million was financed by the Bank. The actual project cost was 4 percent higher thanestimated, mainly due to appreciation of the Japanese yen against the US dollar. Withhigher project costs and lower international prices, the new plants' economic rate ofreturn has been calculated at just 7 percent (based on gas price of US$2/mmbtu),compared to an SAR estimate of 15 percent.

21. Modernization of Gresik's phosphate plants is also showing a positive result insignificant reduction of air and water pollution level. The total cost for this componentwas US$13 million (SAR estimate US$15.8 million), of which US$8.7 million wasfinanced by the Bank.

22. PT Pupuk Iskandar Muda. PT PIM revamped its ammonia plant to increaseproduction capacity from 1,050 tpd to 1,210 tpd (15 percent) and reduced energyconsumption per ton of ammonia produced by 8 percent (3.3 mmbtu). PIM also installeda dust emission control equipment which could reduce urea dust emission to less than50 mg/100 Nm3 . Total cost for PIM was US$17.8 million (SAR estimate US$15.2million), of which the Bank financed US$10.7 million. Appreciation of the Japanese yenagainst the US dollar, price increases, and additional materials due to engineeringrevision contributed to the higher project cost. PIM financed the cost overrun from itsequity.

23. PT Pusri. Pusri revamped its Pusri II plant to increase capacity by 150 percent to1,725 tpd and energy use by 30 percent. The revamp was completed in 1994 and cost lessthan the final budget estimate. Pusri also added two urea hydrolizers to remove urea fromits process condensate effluent, and a biological sewage treatment unit. Thisenvironmental project also cost less than budgeted.

24. The total cost for the revamp was US$33 million (SAR estimate US$36.1million), of which US$22.1 million was financed by the Bank. The cost saving wasaccrued from a reduced scope in ammonia plant optimization. In addition, the total cost ofthe effluent treatment project was US$12.4 million (SAR estimate US$4 million) withBank financing in the amount of US$2.8 million. The higher cost was due to theexpanded scope of the environmental program.

25. PT Pupuk Kujang. Kujang revamped its ammonia plant to increase capacity andsave energy. The revamp increased the ammonia plant's capacity daily production to 120percent as planned, and saved about 2.65 mmbtu of gas per ton of ammonia produced.The total cost of this component was US$18.7 million (SAR estimate US$17.4 million),of which the Bank financed US$12.7 million.

26. PT Pupuk Kalimantan Timur. Kaltim modified its Kaltim I ammonia plant toincrease capacity and save energy, and the urea plant to increase its capacity and reducepollution. The ammonia plant capacity increased from 1,450 tpd to 1,800 tpd, adding

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more than 100,000 tpy, and urea from 1,700 tpd to 2,200 tpd. Kaltim I plant is nowoperating fully, indicating better plant availability and reliability than it was before theproject when it operated at 10 to 20 percent below its capacity. Under the project, extraurea capacity also increased by 10 percent. The total cost of this component was US$44.2million (SAR estimate US$41.4 million), of which US$31.7 was financed by the Bank.

C. IMPLEMENTATION RECORD AND MAJOR FACTORS AFFECTING THE PROJECT

27. Lack of Leadership in Policy Implementation. Except for international pricesof fertilizer, basically all factors important to the success of project implementation arewithin the influence of the Government and the PFCs. This is shown by the smoothimplementation of the industry-wide investment program. In policy implementation,however, no specific institution showed a strong commitment and provided an effectiveleadership despite the fact that implementation of FSP required full commitment andcooperation from the Ministry of Finance, MOA, MOIT, and Ekku Wasbang in acoordinated fashion.

28. The Government commitment to guarantee availability of fertilizer products ataffordable, uniform prices proved to be a constraint to introduction of competition intothe fertilizer industry. This commitment requires a complicated and highly administeredinput/output pricing system and is dependent upon a monopolistic distribution systems.While the Government's continued strong concern about the plight of the farmer is welljustified, the policy choice resulted in distribution inefficiency and excessive fertilizeruse.

29. Appreciation of the Japanese yen against the US dollar contributed to higherproject costs in Gresik and PIM. Also, declining international prices are a factorcontributing to unfavorable PFC financial results including lower rates of return at theend of project implementation.

D. PROJECT SUSTAINABILITY

30. The increase of gas input prices and the decline of export prices would adverselyaffect the PFCs' financial performance and would reduce the amount of internallygenerated funds available to finance future capacity investments. At the same time,Government guarantees are unlikely to be available for new external financing as theGovernment has decided to withdraw from financing such productive activities. Underthese circumstances, even with establishment of the Holding company, PFCs' ability tosustain project achievements by relying on internally generated resources appearsunlikely. In this case, external resources will have to be mobilized and appropriateincentives should be introduced to induce private investments.

31. Unless further sector deregulation and privatization are launched, sustainability ofproject achievements and of the PFCs themselves is in doubt. The Holding company,although not necessarily an ideal solution, should help to enhance sustainability if it hasin its agenda a strong orientation toward policy reform. Moreover, it should be furnishedwith dedicated professional staff and must be fully supported by the Government.

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E. BANK PERFORMANCE

32. In 1988, the Bank commissioned a fertilizer sector study that came up with arecommendation that future investments in the sector should be to make fertilizerproduction competitive by international standards and improve the efficiency of thedistribution system. To this end, the study further recommended that the Governmentdevelop a sectorwide investment program and launch sector policy reform with respect toinput as well as output pricing. The study led to identification of this project.

33. In the identification stage, the Bank's strategy was to ensure that fertilizer sectorpolicy reforms would be implemented consistently and in a timely manner to support thedevelopment of the sector. In project preparation, the Bank reviewed the adequacy ofproject design from its technical, financial, economic, commercial, and institutional aswell as environmental aspects. However, greater attention could have been given to theproject design, particularly in the formulation of sector policies for reforms.

34. During appraisal, a commitment were obtained from the Government toimplement an agreed upon statement of fertilizer sector policy, which was signed by theState Minister of National Development Planning. The policy statement, however, wasvague and not broad enough. The Bank appraised the capacity of the PFCs asimplementing agencies of the investment component. However, the Bank was notsuccessful in identifying and agreeing with the Government the suitable agency to beresponsible for FSP implementation. This resulted in ambiguous policy implementationas there was no commitment from the Governrnent with regard to performance targetsand an implementation timetable.

35. Nine supervision missions were fielded during implementation. The missionscontinuously proposed full deregulation of the sector and privatization of PFCs andsuggested a policy implementation timetable. Problems identified and solutions proposedas well as performance ratings given were well-documented in the Form 590s.

36. Although the project did not realize its fullest potential, within the limitation ofthe stated objectives, the Bank generally performed satisfactorily. However, the projectwould have benefitted by better Bank performance during the design-phase of projectpreparation. The loan amount, together with counterpart and cofinancier funds, wassufficient to cover the investment needs and about 3 percent of the amount was canceledat the end of implementation period.

F. BORROWER PERFORMANCE

37. The PFCs independently prepared proposals that led to preparation of theinvestment component of this project. Plant optimization proposals were finalized afterthe loan was declared effective. The proposals met technical as well as financialfeasibility and were acceptable according to Bank standards.

38. The Government's and PFCs' commitments were best displayed by successfulcompletion of the investment program. This reflects excellent project management

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including right selection of consultants and contractors, timely availability of funds fromPFCs' equities and cofinanciers and consistent progress monitoring.

39. On the policy side, the Government, as mentioned elsewhere, has been reluctantto take more comprehensive policy actions to enhance overall efficiency of the sector.Despite important achievement in reducing fiscal subsidies, the high-cost marketing anddistribution system remains relatively intact.

40. Similar to the Bank's, judged from the project achieving its stated objectives, theBorrower's performance has been satisfactory.

G. ASSESSMENT OF OUTCOME

41. The project has accomplished its stated objectives. However, viewed from the factthat it has missed the opportunity to address more fundamental sector issues, theaccomplishments have been limited and overall sector efficiency objectives have not beenachieved. Therefore, the outcome of the project is unsatisfactory.

42. Although all PFCs have implemented their investment program successfully, theirfinancial performance has only partially met expectations. In addition to being caused bydeclining export prices, the lower-than-appraised financial results reflect the impact ofcurrent pricing policies.

H. FUTURE OPERATIONS

43. To anticipate future demand for urea fertilizer, aging and deteriorating plants inPIM, Pusri, and Kujang have to be replaced and external financing needs to be mobilized.To this effect, the Government has to be more committed to full deregulation of the sectorand to privatization of the PFCs so that private investments in the sector can be inducedand fiscal burden from subsidies eliminated completely. Under the current economicsituation this commitment is even more important and needs to be implemented withsome urgency.

44. Support need to be extended to MOA, which is in the process of refining itsfertilizer demand projection methods that will use systematic individual soil analysesmore extensively.

I. KEY LESSONS LEARNED

45. Well-defined policy measures including quantitative targets and timetables shouldhave been agreed with the Government in the design stage. Implementation of thefertilizer policy statement should have addressed more fundamental issues such as fullsector deregulation, competition development, and privatization.

46. Coordination (or the lack of it), while being a classic issue, continues to be animportant ingredient for policy implementation in a multiagency environment. In thiscontext a strong lead agency should have been agreed upon and appointed early in thedesign stage.

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47. Strong technical capability, as shown by the PFCs, is of utmost importance inimplementation of an industry restructuring project that involves adding new productioncapacities and enhancing plant efficiency and productivity.

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PART II: STATISTICAL TABLES

TABLE 1: SUMMARY OF ASSESSMENTS

A. Achievement of Objectives Substantial Partial Negligible Not Applicable

Macroeconomic policies XSector policies XFinancial objectives XInstitutional development XPhysical objectives XPoverty reduction XGender issues XOther social objectives XEnvironmental objectives XPublic sector management XPrivate sector development X

B. Project Sustainability Likely Unlikely Uncertain

x

C. Bank Performance Highly Satisfactory Satisfactory Deficient

Identification XPreparation assistance XAppraisal XSupervision X

D. Borrower Performance Highly Satisfactory Satisfactory Deficient

Preparation XImplementation XCovenant compliance XOperation (if applicable)

E. Assessment of Outcome Highly Satisfactory Unsatisfactory HighlySatisfactory Unsatisfactory

x

TABLE 2: RELATED BANK LOANS/CREDITS

Year ofLoan/Credit Title Purpose Approval Status

Preceding Operations

1. Industrial Energy Establish institutional framework and policies for 1987 CompletedConservation planning. promoting. implementing and monitoring

energy conservation activities.

In parallel. demonstrate the benefits of energyconservation activities in industry throughimplementation of specific energy-efficiencvinvestments in PT Pusri.

Following Operations

None

TABLE 3: PROJECT TIMETABLE

Steps in project cycle Date planned Date actual/latest estimate

Identification (concept review) NA February 21, 1990Preappraisal (executive project summary NA February 1990Appraisal March 5, 1990 May 1990Negotiations NA October 29, 1990Letter of development NA December 10, 1990Board presentation August 7, 1990 December 20, 1990Signing NA January 16. 1991Effectiveness NA NAProject completion NA NALoan closing December 31,1997 December 31,1997

TABLE 4: LOAN/CREDIT DISBURSEMENT: CUMULATIVE ESTIMATED AND ACTUAL

(US$ million)

FY91 FY92 FY93 FY94 FY95 FY96 FY97

Appraisal estimate 22.2 77.3 142.3 179.3 204.3 217.3Actual 33.2 91.2 151.0 173.5 209.8 214.1 214.9Actual as% of adjusted estimate 150.0 118.0 106.0 97.0 103.0 97.0Date of final disbursement October 22, 1997

- 12-

TABLE 5: KEY INDICATORS FOR PROJECT IMPLEMENTATION

Key implementation indicators in SAR/ President's Estimated ActualReport (End of Project Target) (June 1995)

1. Loan Effectiveness May 1991 March 1991

2. Policy Measures

(a) Annual Consultations Not later than October 1991. and Regularly performed from earlythereafter 1992 and thereafter

3. Gresik Restructuring

(a) Annual Consultations- Start construction October 4. 1990 October 4, 1990- Construction and commissioning completed January 1994 June 1994

(b) Plant Modernization- Feasibility Studies and ElAs Not later than June 30, 1992 April 1992

(c) Preparation of EMP not later than November 30, 1991 September 1991

4. Optimization Subproject

- Feasibility Studies and EIA Not later than June 30, 1992 August 1991

5. Studies

(a) Marketing and Distribution- Setting up steering Committee Not later than May 1, 1991- Start June 1, 1991- Completion March 1, 1992 December 1992- Agreement on follow-up actions by GOI May 1, 1992 January 26, 1993 (review with

Bank)

(b) Development of EMP for the Fertilizer sector- Setting up Steering committee Not later than May 1, 1991- Start June 1, 1991- Completion March 1, 1992- Agreement on follow-up actions by GOI May 1, 1992 January 26, 1993 (review with

Bank)

TABLE 6: KEY INDICATORS FOR PROJECT OPERATIONS

Not Applicable

- 13 -

TABLE 7: STUDIES INCLUDED IN PROJECT.

Study Purpose as defined at Status Impact of StudyAppraisal/Redefined

1. Indonesia Fertilizer Mar- Evaluation of fertilizer and rice Completed Input to implementation of FSPketing Study policy with particular reference to

fertilizer distribution andmarketing

2. Development of an Assess Indonesia's environmental Completed Establishment of environmentalenvironmental management standards for the industry and standards for the fertilizer industryprogram for the fertilizer recommend changes and of an environmental manage-industry ment program for fertilizer

producers

TABLE 8A: PROJECT COSTS

(US$ million)

Appraisal estimate Actual/latest estimateItem Local Foreign Total Local Foreign Total

Restructuring of PT Petrokimia Gresik 179.1 126.3 305.4 189.9 126.3 3 16.2Modernization of Phosphate/As plants 6.0 9.8 15.8 4.4 8.7 13.1Optimization of Pusri 11 Urea Plant 17.5 22.2 39.7 11.0 22 33.0Pusri Effluent Treatment Facilities 1.8 2.6 4.4 9.5 2.8 12.3Kaltim I Ammonia/Urea Plant 8.8 37.0 45.8 23.2 31.7 54.9Optimization of Kujang Ammonia Plant 4.5 12.9 17.4 6.0 12.7 18.7Optimization of PIM Ammonia Plant 4.0 10.8 15.2 7.1 10.7 17.8Studies 0.2 0.7 0.9 0.2 0.4 0.4

Total Project Costs 221.9 222.3 444.2 251.3 215.4 466.7

TABLE 8B: PROJECT FINANCING

(US$ million)

Appraisal estimate Actual/late estimateSource Local Foreign Total Local Foreign Total

Equity 143.8 0.7 144.5 170.3 - 170.1IBRD/IDA - 221.7 221.7 - 214.9 214.9Cofinancing (BNI) 78.1 - 78.1 81.0 - 81.0Japanese Grant - - - - 0.4 0.4

Total 221.9 222.4 444.3 251.3 215.4 466.7

- 14-

TABLE 9: ECONOMIC COSTS AND BENEFITS

The five participating fertilizer companies recorded lower rates of return than appraisalestimates. Consecutively, Gresik 7 percent (SAR 15 percent), Kujang 8 percent (SAR 16percent), Pusri 22 percent (SAR 32 percent), Kaltim 14 percent (SAR 32 percent), and PIM 10percent (SAR, NA)

TABLE 10: STATUS OF LEGAL COVENANTS

Cove- Original RevisedAgree- nant Present fulfillment fulfillmentment Section type Status date date Description of covenant Comments

Loan 3.01 (b) (c) 3 C 01/16/91 NA Subsidiary loan agreement with Gresikfor restructuring and modernizationproject.

3.01 (d) (e) (f) 3 C 01/16/91 Subsidiary loan agreement with PIM.(g) Kaltim. Kujang & Pusri.

Project 4.01 (a) (b) I C Annually NA PFCs to maintain project financialfulfilled records and submit audit reports.

Gresik 2.06 10 C 11/30/91 09/9191 Gresik to implement an environmentalmanagement plan not later thanNovember30. 1991.

2.07 10 C 06/92 04/92 Gresik to submit to the Bank appraisalreport and EIA for its modernizationsubproject.

4.01 (a) (b) I C Annually NA Gresik to maintain project financialfulfilled records and submit audit reports.

Covenant Class: Status:I= Accounts/audits 8 = Indigenous people C = covenant complied with2 = Financial performance/revenue 9 = Monitoring, review. and reporting CD = complied with after delay

generation from beneficiaries 10 = Project implementation not CP = complied with partially3 = Flow and utilization of project covered by categories 1-9

funds 11 = Sectoral or cross-sectoral4 = Counterpart funding budgetary or other resources5 = Management aspects of the allocation

project or executing agency 12 = Sectoral or cross-sectoral policy/6 = Environmental covenants regulatory/institutional action7 = Involuntary resettlement 13 = Other

- 15-

TABLE 11: COMPLIANCE WITH OPERATIONAL MANUAL STATEMENTS

There was no significant lack of compliance with an applicable Bank Operational ManualStatement (OD or OP/BP)

TABLE 12: BANK RESOURCES: STAFF INPUTS

Planned RevisedStage of project cycle Weeks US$'000 Weeks US$'000

Preparation to appraisal NA NA 26.1 77.5Appraisal NA NA 8.4 26.1Negotiations through Board approval NA NA 7.6 24.4Supervision NA NA 160.7 456.1Completion NA NA 11.7 25.1

Total NA NA 214.5 609.2

NA: Not Available.

Source: COSR20 as of 12/29/97.

- 16 -

TABLE 13: BANK RESOURCES: MISSIONS

Performance ratingImple- Devel-

Stage of Month/ No. of Days mentation opment Typeofproject cycle year persons in field Specialized staff skills represented status /a objectives problems

Through Appraisal Up to 10 Industrial Specialist, Economists.05/90 Chemical Engineer, Environmentalist.

Operations Officer

Appraisal through Up to 4 Chemical Engineer, Economist.Board approval 12/90 Operations Officer

Supervision 1 05/91 4 2 Industrial Specialists, Consultant S SChemical Engineer, Environmental

Consultant

Supervision 2 09/91 1 Senior Chemical Engineer S S

Supervision 3 03/92 3 Principal Industrial Specialist, Senior U UFinancial Analyst, Senior Country

Officer

Supervision 4 01/93 2 Senior Chemical Engineer, Principal U UIndustrial Specialist

Supervision5 12/93 3 Senior Chemical Engineer, Operations U UAssistant. Senior Operations Officer

Supervision 6 07/94 3 Senior Industrial Specialist. Sector S SRepresentative, Senior Agricultural

Economist

Supervision 7 06/95 4 Industrial Specialist, 2 Financial S SAnalysts, Sector Representative

Supervision 8 09/96 4 Privatization/Finance Specialist. S UFertilizer Specialist. Financial Analyst.

Operations Officer

Completion 10/97 3 Operations Officer. Financial Analyst. SIndustrial Specialist

/a S: Satisfactory; U: Unsatisfactory.

-17 - ANNEX A

ANNEX A: ICR MISSION'S AIDE MEMOIRE

1. For the preparation of the Implementation Completion Report (ICR) under theFertilizer Industry Restructuring Project (loan 3282-IND), a World Bank mission4 led byMr. Kunrat Wirasubrata conducted a field visit from October 20-31, 1997. During thisperiod, the mission met with the Ministry of Industry and Trade (MOIT), Ministry ofAgriculture (MOA), Ministry of Finance (MOF), Coordinating Ministry of Economy,Finance, and Development Supervision (EKKU WASBANG), PT Petrokimia Gresik(GRESIK), PT Pupuk Iskandar Muda (PIM), PT Pupuk Kalimantan Timur (KALTIM),PT Pupuk Kujang (KUJANG), PT Pupuk Sriwidjaja (PUSRI), and PT Asean AcehFertilizer (AAF) and visited the GRESIK plant in East Java and the KUJANG plant inWest Java. A list of key people met by the mission is attached (Annex-1).

2. Due to unexpected external difficulties, the mission was unable to conduct athorough review of project performance and sustainability. These difficulties relatedmainly to two-incidents, i.e. (i) the project sites outside of Java (i.e. PUSRI, PIM andKALTIM) could not be visited since air-traffic to Sumatra and Kalimantan wasinterrupted in the region due to poor visibility; and (ii) senior government officials inseveral key ministries were unavailable to meet with the mission as they had to attend tothe current foreign exchange crisis; the latter also affected resource availability withinRSI. Consequently the TOR for the mission could not be fully executed; a decision ispending on the need for a follow-up mission within the near future to augment the limitedproject data obtained and plant visits conducted so far.

3. This aide memoire summarizes the main topics of the discussions held and themission's findings and recommendations. The views expressed in this aide memoire are,however, the mission's own, do not necessarily reflect those of the World Bank, and aresubject to review by the World Bank management.

4. The mission gratefully acknowledges the very friendly, frank and cooperativeatmosphere of the meetings with GOI and the participating fertilizer companies (PFCs).

4 The mission comprised Messrs. Kunral Wirasubrata (mission Leader. Sector Coordinator. EACIF), Mr. Kurt M.Constant (Sr. Industrial Specialist. IENIM), and Unggul Suprayitno (Financial Analyst, EACIF).

-18 - ANNEX A

SUMMARY

5. The primary Project objectives were to:

* assist GOI in implementing an agreed Statement of Fertilizer Sector Policiesaiming at establishing an internationally competitive industry;

* identify the scope of improved efficiency in marketing and distribution;

* assess the industry's environmental impact and standards, and prepare anenvironment management program; and

* support an industry-wide investment program.

6. At the outset of the meeting the bank team explained that the main purpose of themission was to compare original primary project objectives with actual achievements andstudy the lessons learned during implementation. The mission also stressed thatsustainability and future growth in the Indonesian fertilizer sector would closely dependon successful implementation of crucial sector reforms including policy adjustments andimprovement of overall production and distribution efficiency in Indonesia. Appetite forprivate investment in local projects will reflect international competitiveness of theIndonesian fertilizer sector in terms of financial project performance and input/outputpricing.

7. Furthermore. the mission explained to MOIT and the PFCs outline and format oftheir required contributions to the final Implementation Completion Report (ICR) thatwill be attached unedited for distribution. GOI and the PFCs agreed to provide theirrelevant inputs and the MOIT will consolidate the feedback on the individual projectcomponents and provide a summary on GOI's views and conclusions.

8. MOIT expressed its satisfaction with the project results and the cooperation withthe Bank during all phases of the project cycle. While a number of reforms have alreadybeen implemented such as deregulation of potash, ammonium sulfate and phosphatefertilizers. full deregulation of gas and fertilizer prices at factory-gate is anticipated forthe year 2000.

9. Following its objective of phased sector deregulation, GOI abolished pricecontrols on potash in 1993/94. and on phosphate (TSP/SP36) and ammonium sulfate(AS) in 1994/95. Subsequently GRESIK phased-out TSP production and replaced it bySP36 (super phosphate 36% P,0 5). As a result of these adjustments production cost havebeen reduced and heavy earlier production subsidies for TSP and AS totally eliminatedover the past 2 years.

10. Despite significant increases of urea prices in 1996 (farm-gate by 26.9% andfactory-gate by 41.6%), and 1997 (factory gate by 15%), urea prices have not reachedinternational levels and are still regulated. As a reference, Annex 2 provides a summary

-19- ANNEX A

of March 1997 retail prices in the region. However, the reform continues and subsidizedsales (including tax exemptions) to plantations and estates (cash crops) are being phasedout faster than supplies for food crops, particularly rice. Full deregulation of urea atfactory-gate level is expected for 2000.

11. So far, gas prices have only been partially adjusted. Under current plans and withthe expiration of old gas contracts (the original "Integrated Gas Purchasing Agreement"of 1975 covered a period of 20 years), gas prices are being increased individually plant byplant. The following gas price adjustments have been reported: PUSRI - #11, III, IV$1.00/MMBtu, PUSRI IB $1.50, for export $1.85; GRESIK $2.00 (currently receives$1.00 reimbursements for domestic sales); special price formula (around $1.60 to $2.60)to be negotiated for new projects. According to MOIT, gas-price deregulation should beimplemented around year 2000.

12. Since 1993 when the IFDC Fertilizer Marketing and Distribution Study wasjointly reviewed by the GOI and the Bank, many of the minor recommendations havebeen implemented. including the involvement of small-scale traders at KUD level. TheGOI has continued to support PUSRI's marketing system and its complex task ofdistributing fertilizers within the Indonesian archipelago, and has recently approvedformation of a holding company under PUSRI that consolidates the five participatingfertilizer companies (PFCs).

13. The Holding was established under PUSRI in September 1997 and itsorganizational structure is still emerging. Its objectives are to coordinate and consolidatemarketing and plant operations with a target of overall efficiency improvement in thefertilizer sector and subsequent pooling of domestic and international financial resourcesfor future investments with private sector participation. One of the Holding's firstdecisions was to select KALTIM (Bontang, East Kalimantan) and PIM (Lhokseumawe,Aceh Privince in North Sumatra) as export centers for international urea shipments.While export quotas still set by GOI for 1997, future export planning will be transparentand done by the Holding. The ultimate goal is to achieve full sector deregulation in theearly 2000s. GOI has transferred its shares in the fertilizer industry to the Holding, whichwill ultimately be fully responsible for the management of the industry and its ultimateprivatization. Consequently, GOI will in future only deal with the Holding as the newofficial representative of the Indonesian fertilizer industry.

14. After the study on the Environment Management Program of the FertilizerIndustry, BAPEDAL and MOIT have prepared and implemented environmentalguidelines and emission standards in 1995 for wastewater. Standards for gas andparticulate emissions to the atmosphere will be available by end 1997. The new localenvironmental specifications reflect international emission standards in industrializedcountries. All five PFCs are participating in the new environmental control scheme andhave passed liquid discharge standards ("blue grading").

- 20 - ANNEX A

INVESTMENT PROGRAM

15. Implementation of the investment components was successfully completed. Alltests and guarantee runs met specifications and the project components have been runningsmoothly and efficiently in general.

16. Some adjustments of original budgets were required. They typically resultedfrom (a) scope extensions; (b) streamlining and/or expediting of procurement activitiesand project implementation to maximize economic benefits; and (c) close linkages ofproject tie-ins with annual turnarounds and market developments. Any overruns thatincurred were funded internally and there were no fund shortages. IBRD loan allocationsto the individual enterprises remained unchanged; some disbursement categoryadjustments were required.

17. Flexibility built into the project during appraisal allowed the Bank to approverequests for scope and disbursement adjustments in most instances.

18. Although all PFCs have implemented their project components successfully, theirfinancial performances have only partially met expectations. The disappointing financialproject results reflect the impact of current pricing policies and prevailing lack ofincentives for higher operational efficiencies among state-controlled enterprises. Thesituation has recently deteriorated as a result of the foreign exchange crisis and correctiveaction is urgently required. GOI and the PFCs expect improved sector performances inproduction and distribution through the new Holding.

19. Current price regulations hit the new high-efficiency plants (PUSRI IB andGRESIK) particularly hard. In spite of lowest energy consumption in the country andhigh level of international competitiveness, these plans cannot sustain their operationswithout losses due to local pricing policies. Debt service capability of the enterprises isseriously hampered and future projects may be in jeopardy. Again. GOI and the PFCsexpect improved sector performances in production and distribution through the newHolding.

20. Three additional problems have emerged during the project completion reviewthat covers the full project cycle from the late 1980s until 1997.

* First, old plants have further aged and would not have been able to maintain their pre-project performances that were used without any adjustments as base case for projectanalyses. It turned out that wear and tear in the plants has continued and affectedperformance. The project has helped compensating lower plant availability due toaging by higher and more efficient capacity, but has not always achieved theanticipated maximum levels over longer production periods.

* Second, during project implementation the number of gas users and their capacitieshave increased causing growing downstream competition for gas. As most competinggas users typically pay more for the gas than the (older) fertilizer plants, sustainability

- 21- ANNEX A

of gas supply to the project has deteriorated and may constrain production atmaximum capacity. Hence. sustainability of gas supply has become a critical issue.

Third, despite competent and experienced management, the PFCs are not always fullymotivated to go for maximum profitability, as benefits are usually only marginal. Theavailable bonus systems linked to physical budget performances may not always havetheir full effect.

21. GOI and the PFCs are aware of these problems and confident that the newlyestablished Holding will soon be able to also resolve these issues through consolidationof resources and planning that aims at obtaining maximum synergy effects.

REFORMS IN THE FERTILIZER SECTOR

22. After initial deregulation of potash phosphate (TSP/SP36) and ammonium sulfate(AS) deregulation followed in 1995. Furthermore and following Bank recommendations,the production of TSP as GRESIK was stoppped replaced by SP36; certain parts ofIndonesia started applying ground phosphate rock, where suitable. This has resulted insignificant reductions of production costs and total elimination of the heavy earlierproduction subsidies for TSP and AS At GRESIK (estimated 1993 subsidies were US$60 million for TSP and US$ 15 million for AS).

23. The Coordinating Ministry of Economy, Finance, and Development Supervision(EKKU WASBANG) reiterated that food security, particularly reliable supply of rice, isstill one of the most important Govemment objectives. Hence, there have been substantialdelays in full sector reform. particularly farm gate prices of urea. However, GOI is awareof the potential and need for improved efficiencies in agriculture, industry, anddistribution and agrees that full subsidy removal should be the ultimate goal of the reformprogram. As a first (and probably temporary) consolidated initiative toward improvedindustrial fertilizer activities, GOI feels confident that the establishment of the newHolding will provide valuable contributions including introduction of least costdistribution and synergy in projects, operations. and marketing.

24. The mission feels that the Holding is probably not the ideal solution, but is likelyto help achieving substantial improvements on the short to medium term. In order tofacilitate its success it will need to be properly staffed and have access to highest qualitylocal and international expertise, as its required role will be exceptionally demanding andimportant. Additionally, final and annual targets and objectives of the Holding should bequantified and integrated in its budgets as soon as possible. MOF. MOIT, EKKUWASBANG and the Holding agreed that the long term goal of the reform is sectorderegulation and privatization of the fertilizer enterprises in a competitive environment.

25. The Ministry of Agriculture is working on revised fertilizer demand projectionsand there is increased interest in fertilizer recommendations based on systematicindividual soil analyses. Unfortunately, availability of funds for the piloting appropriatesoil sampling, analyses and fertilizer recommendations is very limited at this stage. The

-22 - ANNEX A

mission indicated that under the newlv introduced Learning and Innovation Loans (LILs),the Bank may be in a position to provide assistance and offered to follow up on this topic.

26. Despite significant increases of urea prices in 1996 (farm-gate by 26 percent,factory-gate 41.6 percent to Rp. 246.750/t.bagged), and 1997 (factory-gate Rp. 282,900,bagged). urea prices have not reached international levels and are still regulated (seeAnnex 2). However, subsides for sales to plantations and estates are being phased out asGOI redirects its focus on secure food crop production only. Unfortunately, the issue ofurea pricing has been seriously aggravated by the recent Rupiah crisis.

27. GOI's export quotas are still set in reverse to individual enterprise (energy)efficiencv thus turning less efficient plants into main exporters to compensate for higherproduction costs-there is a lack of incentives for increasing operational efficiency.Changes are expected for 1998 and thereafter with the evolution of the Holding that willtake over sector budgeting and operations.

28. Under current conditions. substantial subsidies are still required for coveringprevailing high marketing and distribution costs despite initial attempts to introduce theconcept of 'least cost distribution'; natural gas forms a major part of current fertilizersubsidies.

29. The current price structure for urea production and domestic sales does not allowthe most energy efficient producers to cover their costs, even with a subsidized gas priceof US$ 1/MMBtu. The financial situation is particularly serious for the two new mostefficient plants at FRESIK and PUSRI. as they have made substantial investments thatare verv difficult to recover under prevailing circumstances. Thus pricing reform isbecoming ever more important and urgent.

30. The future of the fertilizer companies depends to a large extent on the speedysuccess of the new Holding in achieving improvements in sector performance andprofitability, catalyzing pricing reforms and facilitating ultimate sector deregulation.Fertilizer production and distribution play a very critical role in Indonesia's agricultureand should meet the following requirements in the field:

o appropriate type of fertilizero timely supply/availability to the farmero satisfactory amount* good quality* acceptable pricev right location

The measure required for meeting these targets in an economic and efficient way shouldinclude:

deregulations of marketing and distribution at all levels to promote sector-wide efficiency gains;

- 23 - ANNEX A

. at GRESIK, further technology upgrading and diversification to speciallyformulated blend and complex fertilizers;

* increase of urea factory-gate prices to economic levels in order to* make urea production for the local market financially viable;* encourage industry performance optimization; and* attract private sector participation that is warranted to realize the

potential for further industry development and fertilizer exports;* adjustments of gas input prices to reflect economic values in order to secure

future gas supplies and enhance energy efficiency.

FERTILIZER MARKETING AND DISTRIBUTION

31. The Fertilizer Marketing Study by IFDC was completed in late 1992 and jointlyreviewed by GOP and the Bank in early 1993; a follow-up meeting was held in mid-1993. Although the majority of the study's minor recommendations has been acceptedand implemented, the Government has been reluctant to introduce major changes in viewof its desire to keep uniform fertilizer prices throughout the country and ensure reliabledelivery.

32. Average 1996 fertilizer marketing and distribution costs in Indonesia haveescalated and reached a comparably very high level (around US$ 50/ton; Philippinesaround US$ 20-25/ton; Indonesia cement around US$ 20/ton and less excluding levels IIIand IV). In the past. only a small percentage of the national fertilizer trade (about 10percent) was used outside of Java and Sumarta; due to recent developments in SouthSulawesi and Kalimantan. the 10 percent have apparently recently increased to about 20-25 percent. Marketing and distribution costs within Java should not exceed US$ 10-15/ton of supplies from the local fertilizer producers (GRESIK, KUJANG). Hence, directmarketing from local plants into their neighboring markets, particularly in Java andSumarta (least-cost distribution) would yield substantial annual savings, conservativelyestimated at US$50-60 million equivalent based on estimates by previous Bank missions.

33. There is clear evidence that substantial additional benefits may be obtained byrestructuring the marketing and distribution system. As successful internationalexperience in sector reform show, uninterrupted and efficient product flow into themarkets can be ensured through careful design and proper phasing. Remote areas mayjustify special treatment and support to ensure acceptable product availability and prices,and should be targeted in a transparent and manageable manner.

ENVIRONMENT

34. In cooperation with BAPEDAL, MOIT has finalized and accepted wastewateremission standards in the fertilizer sector that are based predominantly on EC standards.Work on air pollution standards is progressing and should be completed by 1997. An

-24 - ANNEX A

appropriate monitoring and enforcement plan has been prepared and all five PFCs areparticipating in the scheme and have passed.

35. Besides the environment management program and its implementation in thesector, which is fairly advanced, the project has significantly contributed to pollutioncontrol in all factories. Measures taken include reduced emission of greenhouse gases,energy conservation, reduced contamination of liquid effluents and reduction in effluentstreams with an anticipated zero liquid effluent from Kujang in late 1998, and substantialimprovements in operating conditions and operational safety, particularly at PetrokimiaGresik, where the old oil-based ammonia plant was replaced and the existing phosphateand TSP complex modernized.

- 25- ANNEX A

INDONESIA

FERTILIZER INDUSTRY RESTRUCTURING PROJECTSENIOR PEOPLE MET BY THE MISSION

Ministry of Industry & Trade (MOIT): Mr. H. Ahmad Gazali Director, Chemical IndustryMr. Agus Wahyudi Chief, Productions, Chemical Industry

Coordinating Ministry of Economy. Finance and Proiect Supervision (EKKU WASBANG):Dr. Delima Azahari Director

Ministry of Finance (MOF)Mr. Bacelius Ruru Director General, State Owned CompaniesMr. Ragil Moegiyo Hadisukarto Head, Sub-directorate, Industrial State Enterprises

PT Petrokimia Gresik (GRESIK):Mr. Aan Ruskanda Furkon Technical DirectorMr. Yusuf Budianto Business Development Manager

PT Pupuk Kalimantan Timur (KALTIMI:Dr. Anwar K. Joesoef Director, Research & DevelopmentMr. Bowo Kuntohadi Director, Finance & CommerceMr. Eko Sunarko General Manager, Finance

PT Pupuk Sriwidjaia (PUSRI):Ir. Suhadi President DirectorIr. Kadar Suradimadja Director, R & DIr. Setyabudhi Zuber Project Manager, PET

PT Pupuk Kujiang (KUJANG):Ir. Edi Madnawidjaja President DirectorIr. Rukasah Daradjat Director

PT Pupuk Iskandar Muda (PIM):Drs. Omay K. Wiraatmadja President DirectorMr. Wiyas Yulias Hasbu Commercial DirectorMr. Suarto Budidarmo Research & Development Director

PT Asean Aceh Fertilizer (AAF):Mr. Z. Soedjais President Director

-26 - ANNEX A

FERTILIZER RETAIL PRICESIN SELECTED ASIAN COUNTRIES

(United States dollar per metric ton - March 1997)

Country Urea AS Rock P. SSP ISP Potash

Bangladesh 122 - - 133 299 164China 249 - - 49 - -India 92 - - 77 - 125Indonesia 141 151 - - 276 224Iran 86 43 - - - -

Korea, Rep. 220 114 - 84 - 211Malaysia 288 178 153 - - 198Myanmar 5,010 - - - 3,340 1,169Nepal 118 121 - - 140 149Pakistan 164 97 - 105 - -Philippines 293 170 - - - 296Sri Lanka 194 162 93 - 226 198Thailand 230 144 - - - 183VietNam 252 177 - 92 - 162

Source: FADINAP Fertilizer Trade Information Monthly Bulletin, March 1997.

- 27 - ANNEX B

ANNEX B: BORROWER'S COMMENTS ON THE ICR

PT PUPUK KUJANG(PERSERO)

I9utea PUSHt: Kaine, Jaoww-JL .lwd. A. Ymni No.39 CknMP.k A1 2T7 Godung Umawir LL 116111Jaw s at - Indamese PO. 3ox 4 CkIl JL K)amen F. Tewen Kav. No. 28TdIp: (O2664 318141 Nufling ysylto Pt. 30x 137? -¶10013

3t4336, 31437,314=38, 314339 Jakattn S"tanfli271* Indoneoa314340. 314 '1, 314342 TdtOL (021t 5224225. SZ0427, 520223S

Fe* (OI)3142!38,314W3 Fox (021) 5204233Tl=: 440 KWJANG IA Tese* 62478 eKrIA

Jakarta, Jbne 12, 1998Our ref.: Z35/PKJ/DU/VI/98

ToThe Wold Bauk1818ii Street mTW.Washington, D.C. 20433U S A

Attn.: Mr.. Soonm Mbk ChmugSector ..anagerFimnaceand Private Sector DevelopmentF-ast Asia and Pacific iegion

Subject :FertilUier Restructuring Project (Loan: 3282-2MD)

Draft Immlemnntation Coamletion Reiort

Dear Sir,

In response to your letter dated June 1, 1998 regarding the above subject,

please find our comment and correction as follov

?a=agraph 2 : Achievmnmt of Obi ect±ve

Sub peragraph.2.18 : PT? 'upuk Xu a=g. _Kujang revamped ......................

Trhe revame increasa the ammoni-a plant's d&i1' aunLia mroduction to 120

2ereent as planed, and saved about 2.63 XM3TU of xas per con of a=onia

producad. Totai cost of ....................................................

The above correction is made in accordanca vith the Perfor=ance Test Result

which is signed by Rellogg's and Kujan-'s representative (Attached).

The 114Z Figure mentioned in that Sub paragraph actually i3 the achieved

natural feed gas through put figure, not the ammonia production.

Therefore, the. natural gas savtng of Z.65 QM3TU per ton of a=ouia, is the

obtained saving achieved by the investment, which is now to produce the

plant out out of 120%. the a&o=_±a plant uses only 114% natural -as through

put compared to 120% before the project.

Thauk vou for your kind attention.

Yours stncerelv,

se

Note:aThe atachments t l a i w e t

Note: The attachments to this letter are not included with the ICR but are available on file.

BORROWER'S COMMENTS ON ICR(Received June 25, 1998)

CORRECTION OF DRAFT IMPLEMENTATION COMPLETION REPORTFERTILIZER SECTOR RESTRUCTURING PROJECT

LOAN NO. 3282-IND

No. Subject World Bank Comment and Recommendation Correction

Implementation of Fertilizer (Page 2. para 9) AdditionalSector Policies Page 6 13 (9). . As a result, production cost have been reduced and

2.3. As a result production cost have been reduced subsides for TSP and AS totally eliminated over the past two years.and subsidies for TSP and AS totally eliminated over Although not totally eliminated, overall budget subsidies havethe past two years. Although not totally eliminated, decreased from Rp. 457 billion in FY 1992/3 to Rp. 195 billion inoverall budget subsidies have decreased from Rp 457 FY 1996/97. But since US dollar over valued to rupiah duringbillion in FY 1992/3 to Rp 195 billion in FY 1996/7. monetary crisis, production cost become extremely high. 00

However, subsidy for SP 36 and SA have been reappeared sinceApril 1998.

2. Implementation of Fertilizer (Page 3. para 10) Corrected should beSector Policies Page 6 2.4. (10) .... The following gas price adjustment have been

2.4 ... The following gas price adjustment have reported: US$1.85/mmbtu for Pusri's plant numbers 11, III and IV,been reported: US$1.00/mmbtu for Pusri's plant US$1.50 for Pusi plant number l-B. PK Gresik numbers 11, 111 and IV, US$1.50 for Pusri Plant numberI-B, for export US$1.85; PK Gresik .

3. Implementation experience (Page vi.. para 9) AdditionalPage 3, point 9 * Pusri Holding was formed on 7 August, 1997, comprising PT.

Pusri as holding and PT Pupuk Kaltim, PT Petrokimia Gresik,PT Kujang and PT Pupuk Iskandar Muda respectively assubsidiaries.

* The main goal of the holding among others are: to improvenational productivity and efficiency as well as competitive and

No. Subject World Bank Comment and Recommendation Correction

to gain the synergy effect in the future business development.* The holding policy on the synergy program are as follows:

a. Marketing Aspect:=> Fertilizer product is mainly for domestic user and the

excess will be exported.=> The export point through Bontang port (PT Pupuk Kaltim)

and Lhok Seumawe port (PT PIM) based on the least costdistribution principle and better price.

b. Production Aspect:

r Fertilizer plants will be operated as optimum as possibleaccording to the design capacity by implementingbenchmarking program.

c. Finance Aspect: Io

: Fund and financial management will be implementedeffectively and efficiently based on the cost and benefitanalysis.

d. Development Aspect:

= Business development plan will be carried out based onresources availability.

=> The similar project proposed by the group member ofholding will be decided based on the most profitablelocation.

ze. Engineeringf& Other Technical Services Aspect:

=> Working facilities and other technical services will be

No. Subject World Bank Comment and Recommendation Correction

utilized fully for internal requirement prior to outsoarcingand the outside marking as well.

.=> The above facilities will be managed based and businessorientation by utilizing available resources.

Additional:a. Information on Fertilizer Sector Policies

+ Restructuring and deregulation on the distribution andmarketing will be done phase by phase considering subsidizedand non subsidized fertilizers, the type of the fertilizer andutilization on the fertilizers.

+ Experiences showed when the Indonesian Government liftedsubsidy of KCI fertilizer, the demand dropped almost half ofthe initial consumption due to the increased price.

+ As far as the rice price controlled by Government, all the ofarmers requirement to the produce rice should be controlled aswell. Otherwise the farmers will be reluctant lo-grow rice.

+ The success of deregulation program depend on the lowdistribution cost and the adequate supply of fertilizer to thefarmer.

b. Information on Fertilizer Demand Projections

* The national fertilizer requirement plan did not consider thesoil analysis and various constrain. Instead the fertilizerrequirement was planned by agricultural official both from thenational and the provincial level. Pusri which is responsible>for the fertilizer distribution for the agriculture evaluates the zfertilizer requirement, and considers the pasi fertilizerconsumption to insure adequate supply. t;

No. Subject World Bank Comment and Recommendation Correction

5. Environmental Management (Page 4 para 17) Corrected should beProgram Page 7. 2.10. For air quality, the program is just beginning as the standards

2. 10. For air quality, the program is just beginning as will not be enacted until late 1997 and emission monitoring hasthe standards will not be enacted until late 1997 and begun since PGCs adopting ISO 14000.mission monitoring has not begun.

(Page 4 para 19)6. PT Petrokimia Gresik Page 7. Corrected should be

Restructuring 2.12. The new ammonia and urea plants have been 2.12. The new ammonia and urea plants have been placed inplaced in service since 1994 and modernization of PK service since 1994 and modernization of PK Gresik's phosphoricGresik's phosphoric acid and AS facilities has been acid and sulfuric acid (SA) facilities has been completed and incompleted and in operation since 1996. operation since 1996.

Note: Please refer to new paragraph numbers. in parenthesis as report numbering was changed.

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