Business Articles 2005 - Part 1

No significant progress in government-Cemex dispute 

 

Wednesday, January 26, 2005 Vincent Lingga, Jakarta

The President's lack of leadership to act firm and fast in resolving the government's four-year dispute with Cemex over the Mexican company's investment in the state-controlled Semen Gresik Group (SGG), could cost the government half a billion dollars and longer delays in the return of foreign direct investment.

It is now almost three months since the government initiated negotiations with Cemex to iron out an amicable solution to the impasse.

But it seems that no substantial progress has been made, despite a string of official claims that a final resolution is imminent. Indeed, State Minister of State Enterprises Sugiharto took everyone for a ride when he said a memorandum of understanding would be signed on Tuesday.

The government initially appeared determined to resolve the Cemex case, as one of four high-profile disputes with foreign companies it expected to settle during the first 100 days of its rule to jump-start the inflow of foreign direct investment (FDI).

However, the only achievement thus far has been Cemex's temporary (60 days) suspension of arbitration proceedings on its claim at the International Center for the Settlement of Investment Disputes (ICSID) in Washington.

A costly, messy lawsuit still looms over the government, and its failure to reach a basic agreement by February could trigger litigation proceedings at the ICSID, a World Bank affiliate. And, given its frustration with the capricious stance of the previous administration, Cemex will not likely commit to anything, unless it is absolutely sure of a smooth, clean deal.

The government has insisted that it proposed six options to resolve the dispute, but most of them are either politically unacceptable or commercially and fiscally unfeasible. It has ruled out selling its 51 percent stake in the SGG and buying out Cemex's 25.50 percent holding in the SGG.

The most commercially viable solution acceptable to both parties seems to be the option disclosed by Coordinating Minister for the Economy Aburizal Bakrie in November, after flying around the world to initiate a series of initial negotiations with Cemex management in France, Chile and Mexico.

Aburizal then said the government would sell three units of PT Semen Gresik, one of the SGG's three subsidiaries, with a total capacity of almost seven million metric tons to a new joint-venture company to be controlled by Cemex.

The other two subsidiaries of the SGG are PT Semen Padang in West Sumatra, with a capacity of five-and-a-half million tons, and PT Semen Tonasa in South Sulawesi, with three-and-a-half million tons.

Under this option, the government would maintain its 51 percent control of the SGG, but the holding company would retain only the other two subsidiaries, Semen Padang and Semen Tonasa.

This transaction, besides halting the litigation process -- which could otherwise inflict US$500 million in losses on the government -- would bring in hundreds of millions dollars in fresh capital to the SGG, which it could immediately invest in building a green-field cement factory to capitalize on the steadily rising demand for building materials.

Most analysts have predicted that, based on the current annual economic growth of 5 to 6 percent, Indonesia would see a significant cement deficit in 2007 if the industry does not increase its capacity.

Yet another important effect is the greatly positive signal the settlement of the dispute would give to foreign investors.

Sadly, though, even before the government and Cemex began serious negotiations over the basic principles of how to implement this option, PT Semen Gresik's "trade union" has launched a massive campaign to torpedo the plan.

The "trade union" -- fully backed by Semen Gresik's management -- has lobbied the House of Representatives, trumpeting fear that the government's sale of the cement unit would make the country vulnerable to cartel-like practices in the cement trade.

But this campaign seems to be modeled on the "rebellion" of the previous Semen Padang management, which, with the support of vested-interest politicians and senior officials in West Sumatra, succeeded in blocking the government's put option to sell its 51 percent stake in the SGG in October, 2001.

Rent-seekers in West Sumatra, in a desperate attempt to maintain Semen Padang as their cash cow, also whipped up narrow nationalistic sentiments against the government's plan to sell its controlling stake in the SGG.

Unfortunately, though, the then Megawati government, notorious for its lack of political leadership, simply succumbed to the rent seekers and left behind a time bomb for the new government of President Susilo Bambang Yudhoyono to defuse.

Even now the SGG holding company still suffers from the damaging impact of the Semen Padang rebellion.

Even though SGG shares were still traded on the Jakarta Stock Exchange, the SGG's consolidated financial reports for 2002 and 2003 were classified by its independent auditors with a disclaimer. No one really knew the actual market value of the SGG until the findings of a forensic audit, ordered by SGG shareholders on PT Semen Padang last year, were disclosed.

But the Susilo government seems about to repeat the mistake of its predecessor.

The ministerial team of privatization is not so ignorant as not to know that, what is claimed to be the Semen Gresik "trade union" is actually synonymous with Semen Gresik's management because virtually all the union leaders consist of the company's management and heads of divisions, departments or sections.

Blue-collar workers, who make up 90 percent of Semen Gresik employees, seem not represented in the trade union leadership.

This clearly indicates that what the union leaders claim to be the aspirations of Semen Gresik workers and the local people is actually the vested interests of those in the current management who want to do "business as usual".

Yet, the government seems unable to adequately respond to the rent-seekers' negative campaign and xenophobia sentiments.

The government should demonstrate its political leadership to resolve the dispute, once and for all, by making a firm decision on what it feels to be best for national interests, rather than bowing to political pressure from vested interests, who claim to represent the workers and local people.

The stakes are high, both in terms of potential financial losses and severe damage to the government's credibility.

The Susilo government, which has gained such a strong political mandate, should be able to make a bold -- albeit politically unpopular -- decision, as long as it is highly accountable, and in the best interests of the people.

The writer is Senior Editor at The Jakarta Post

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Preparing public for higher fuel prices

Thursday, February 24, 2005

Vincent Lingga, Jakarta

While economic rationale was initially the main demand arising from the plan to increase fuel prices, discussion is now focused on how to make the painful measure politically acceptable to the House of

Representatives and palatable to the general public.

Virtually no one will argue against the economic necessity to cut the huge fuel subsidies, most (80 percent) of which have been enjoyed by people of the middle- and high-income brackets.

Fuel subsidies, which could explode to over Rp 70 trillion (US$7.8 billion) this year, also cut into the budget for poverty alleviation and other social safety net programs, and threaten fiscal sustainability.

Even more damaging is that subsidies encourage gross inefficiency in fuel use -- while the country has now become a net oil importer -- hinder the development of alternative energy and make export smuggling a highly lucrative business.

However, as the government experienced in early 2003, what had been established as economically rational and approved through a national political consensus at the House was not automatically accepted by the general public.

The government in late January, 2003 was forced to scale back the fuel price hikes it introduced early that month due to a massive wave of demonstrations, thereby damaging its policymaking credibility.

Public acceptance, which is the key to the effectiveness of the upcoming fuel-price increase to achieve its objectives, will depend on whether the reform can be promoted as fair.

Therefore, the bold move to slash fuel subsidies, which is expected before the end of next month, cannot be conducted as a single, isolated measure. It must be introduced in a package with other programs to ensure fairness in sharing the burden and to build a conducive environment for rational public opinion. .

And the price increase should not be so steep as to unduly shock the economy.

This is what the government has been preparing for the last few weeks, though the process has been rather slow and haphazard.

The government is trying to establish fairness through the protection of the poor from bearing the brunt of the higher prices. The government has said it will maintain subsidies for kerosene, the most widely used fuel in poor households.

A Cabinet meeting last week decided to increase budgetary appropriations for helping poor families bear the higher prices to almost Rp 18 trillion from Rp 7.3 trillion originally allocated. These funds will be used for health services, education, rice subsidies, rural infrastructure and public housing.

But public acceptance also depends on the government's willingness to take on its full share of the burden through minimizing waste and inefficiency caused by corruption and by truly behaving and acting out of a real sense of urgency and crisis.

The government should go all out to convince the people that the fuel-price hike is really for their benefit, otherwise a new bout of social unrest could surface at the expense of economic and political stability.

The government needs to establish a reliable mechanism for ensuring that the poor are fully protected from the additional burdens to be inflicted by the new fuel-pricing policy -- that is, that the remaining subsidies reach their target beneficiaries.

Encouraging, though, is that the government already has a fairly comprehensive map of the country's poverty pockets so that the various forms of assistance have a better chance of reaching their target beneficiaries.

However, the government and business leaders are yet to sit down and calculate the impact of the higher fuel prices on production costs for goods and services, and the central bank needs to design appropriate monetary policies to manage anticipated inflationary pressures.

These preparations are all necessary to prevent a reaction of panic. At a time when many people are still suffering the brunt of the economic crisis and millions of others are either unemployed or underemployed, additional burdens stemming from higher fuel prices could easily incite public anger.

The absence of justice and an equitable sharing of burdens could sabotage the whole reform movement.

Massive street demonstrations, such as those in early 2003, would only make things murkier, increase uncertainty and affect political stability. This in turn could press down the rupiah exchange rate and consequently further increase fuel prices and foreign debt servicing at the expense of government spending on social safety net programs.

Moreover, it would be almost impossible to do business under a wildly fluctuating exchange rate.

There are only a few weeks left for the government to consult the House about the planned fuel-price hike, prepare the business community to cope with its consequences and sell the idea to the general public.

Time is not on the government's side. Delaying the measure would only create uncertainty, breed speculation and further damage the government's policymaking credibility.

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Corruption at Pertamina looms over fuel price hikes

Wednesday, March 09, 2005

Vincent Lingga, The Jakarta Post, Jakarta

So what! That may be the skeptical reaction of most people to the ruling by the Business Competition Supervisory Commission that state oil and gas company Pertamina and three of its business partners conspired to rig the tender for the sale of two very large crude carriers in mid-2004.

After all, many previous rulings in high-profile cases have been overturned in appellate courts on technicalities or procedural faults, despite the painstaking work of the antitrust body to build its rulings based on well-documented evidence.

The commission's ruling on the tanker sale also seems to have been based on well-documented evidence, capping almost eight months of poring over 291 documents and questioning 26 witnesses.

The conclusion, announced last week, simply validated the allegations by the Pertamina union and several anticorruption activists, who last year campaigned to block the tanker sale but succeeded only in creating a nationwide controversy and headline stories for a few days.

The evidence pieced together by the commission showed that Pertamina and three other companies -- Frontline Ltd., Goldman Sachs and PT Equinox shipping company -- conspired to rig the tender in the favor of Frontline, causing between US$20 million and $56 million in state losses.

The commission concluded that they violated Article 19 of the antimonopoly law prohibiting businesspeople from discriminating against other business players, and Article 22 banning businesspeople from conspiring to determine the winner of a tender.

Some of the evidence pieced together by the commission:

* Pertamina selected Goldman Sachs as the financial adviser and arranger of the tender without a beauty contest (competitive bid), in violation of government regulations.

* Frontline, which eventually won the tender, was allowed to submit a bid, through PT Equinox, as its Indonesian agent, after the deadline for bids had passed.

* The opening of Frontline's bid was not witnessed by a notary public, as Goldman Sachs required for the two earlier bidders.

As early as last September, after 30 days of preliminary investigation into the controversial tanker sale, the commission found strong indications of unfair competition in determining the winning bidder, and duly notified Pertamina and related parties of the findings.

However, Pertamina went ahead with the tanker sale, saying it faced severe cash flow problems, the tender was fair and transparent and Frontline was declared the winner because the other two bidders could not put up a 20 percent down payment and US$5 million surety bond for each of the two tankers.

The commission's findings only strengthened the public's suspicion about deep-rooted gross inefficiency and corruption at the state oil monopoly. And these findings certainly insulted the public's sense of justice, particularly as people now strain under the burden of the recent fuel price increases.

Rent-seekers seem to have re-entered Pertamina, especially after former Caltex Pacific Indonesia CEO Baihaki Hakim, who was appointed in February 2000 by then president Abdurrahman Wahid to clean up the state company, was replaced in September 2003.

It was Hakim who decided to order the two very large tankers in late 2002 from South Korea, in a bid to eliminate the mafia-style business practices that had cost the company hundreds of millions of dollars in tanker charges, as confirmed by PriceWaterhouseCoopers in a special audit in 1999.

Remember the controversial sale by tender of PT Indomobil, Indonesia's second largest automobile group, by the Indonesian Bank Restructuring Agency (IBRA) in late 2001?

The antitrust body, after three months of examining 170 documents and questioning dozens of witnesses, ruled in April 2002 that the three final bidders -- PT Bhakti Asset Management, PT Alpha Securitas Indonesia and PT Cipta Sarana Duta Perkasa -- had conspired to ensure Cipta Sarana won the bid.

The ruling, also built on well-documented evidence, stated that Cipta Sarana, an unknown company set up only in December 1998, did not qualify for the tender.

Similar to the Pertamina case, the commission discovered many circumstances and occurrences that raised disturbing questions about the integrity of the tender process.

However, all of the commission's rulings in the Indomobil case were overturned by appellate courts.
The commission also lost the case against Garuda's ticket reservation system and against the Jakarta International Container Terminal's alleged monopoly at the Tanjung Priok Port in Jakarta.

Many legal experts have questioned the technical competence of judges in the appellate courts (district courts and the Supreme Court) in dealing with complex business transactions.

But the commission suspects corruption in the district courts is one of the main reasons it lost these cases. In July 2002, the commission, frustrated by its many defeats in the district courts, demanded an audit of the assets of those judges who overturned its rulings. But again nothing happened.

Will the same thing happen to the commission's ruling on the tender for the tankers?

The answer could be yes, given the snail's pace of reform in the judicial system.

The situation is, however, not entirely hopeless. The March 1 fuel price increases have angered so many politicians, student leaders and activists that the government may have to act strongly on the commission's findings, otherwise public opposition to the new fuel policy will become much stronger and the government's credibility in fighting corruption will be eroded.

The writer is a senior editor at The Jakarta Post.

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Philip Morris buys a piece of Indonesian history

Tuesday, March 22, 2005

Vincent Lingga, Jakarta

Julius Tahija surprised the financial community in mid-1997 when he sold to the Soemitro Djojohadikusumo family his 40 percent stake in Bank Niaga, a sound, rapidly growing bank, that was then ranked 7th largest in the country.

The Tahijas certainly got a premium price (US$291 million) for the deal as the banking industry was then in its heyday after steadily robust growth spurred by the 1988 banking deregulation package.

However, less than one year later, Indonesia's banking industry collapsed, and the government was forced to nationalize all the country's largest banks, including Bank Niaga.

The Djojohadikusumos lost their entire investment.

In an even bolder move that shocked the tobacco industry last week, the Sampoerna family sold their 40 percent holding in PT Handjaya Mandala Sampoerna, a clove-cigarette (kretek) maker, for $2 billion to Philip Morris International Inc.

The Sampoerna founding family also gained a premium price, this time around 20 times estimated 2005 earnings, with very good reasons. PT HM Sampoerna is the second largest cigarette producer in the country, and Indonesia is the world's fifth largest cigarette market with total sales of about 215 billion cigarettes worth about $8.5 billion last year, more than 90 percent of which were kretek.

Both transactions demonstrated the great business acumen of the Tahijas and Sampoernas -- getting out of their respective businesses at the peak of their performance.

The Tahijas might not have been so politically and economically seasoned to predict the banking collapse within such a short time. But they accurately foresaw in July 1997 that while the banking industry is a vital component of the economy, it is a capital-hungry business that does not fit well with their business-risk profile.

How accurate their projections have been.

The 2004 bank architecture launched by the central bank has imposed such high capital standards that the country's 134 banks will gradually be forced to consolidate into two or three international-class banks and only three to five national anchor banks, with the rest downgraded to specialized or rural banks.

Whatever their reason -- whether commercial or moral grounds, given the large number of deaths blamed on smoking-related illnesses -- the Sampoernas' decision was a brilliant business move.

By one stroke, the Sampoernas got the equivalent of $2 billion in cash while at the same time leaving their family trove in the care of Philip Morris, the world's largest cigarette maker, which says it will expand the kretek market to other Asian countries such as China.

But the similarities between the two transactions stop here.

Philip Morris will not likely meet the tragic end that befell the Djojohadikusumos with their bank acquisition. The cigarette industry will not collapse, at least not within the foreseeable future, despite the increasingly strong antismoking sentiment.

Cigarettes are an addictive product and addicts are the ideal, most loyal consumers, especially in Indonesia where there are no significant restrictions on smoking.

Philip Morris must have made a thorough assessment of the kretek market, otherwise the cigarette giant would not plan on making an offer for the remaining 60 percent of PT HM Sampoerna, which, if accepted, will increase the value of the company to around $5.2 billion.

Given its role as the world's largest cigarette maker, Philip Morris must have spent a great deal on researching smoking habits in Indonesia. As the adage within the advertising industry says "If you want to get into people's wallets, first you have to get into their lives."

Philip Morris should have been fully aware of Sampoerna's massive marketing network throughout this vast archipelagic country that could be tapped for other consumer goods.

Unlike in most developed and newly-industrialized countries, where smokers have increasingly been treated as outcasts, and the industry has constantly been battered by antismoking activists, Indonesia will most likely remain a paradise for smokers.

Philip Morris, like other cigarette companies, can operate and market its products virtually without restrictions on nicotine, tar content and advertising.

Even though antismoking activists have attacked the cigarette industry as being evil, many observers here link clove cigarettes with Indonesia's history, culture and identity

"Clove cigarettes are part of the fabric and tradition (in Indonesia)," Philip Morris's President for Asia Pacific Matteo Pellegrini observed in remarks to reporters early last week.

"Kreteks capture the soul of the nation," notes Mark Hanusz in his book Kretek: The Culture and Heritage of Indonesia's Clove Cigarettes".

This factor and the significant economic role of the industry as the direct employer of more than 300,000 workers and millions of others in distribution, retailing and the growing of tobacco and cloves, and its huge excise tax contribution have prompted the government to remain highly tolerant of smoking and omnipresent cigarette advertising.

However, the antismoking camp has stepped up its campaign and things may not be so rosy for smokers in the future, at least in Jakarta for a start.

The Jakarta municipal administration has raised the momentum of the antismoking campaign through a bylaw that will ban smoking in public places, such as offices, buses, trains, airplanes, airport terminals, shopping malls, restaurants and hotels, starting next year.

Many may be skeptical about the bylaws enforcement. But by criminalizing smoking, the new regulation will empower individual non-smokers and antismoking organizations to initiate lawsuits against recalcitrant smokers and cigarette companies.

The antismoking campaign in other cities will also get a boost as the regulatory framework will gradually change the perception that smoking is simply a matter of lifestyle choice.

If the Jakarta example is followed by other cities, Sampoerna's top-selling brands Dji Sam Soe and A Mild, and Philip Morris's top-selling brand, Marlboro, will be among the hardest hit as their consumers are mostly middle and high-income people.

The writer is a senior editor of The Jakarta Post.

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Tax amnesty suggestion has powerful support in Cabinet

Wednesday, March 30, 2005

Vincent Lingga, The Jakarta Post, Jakarta

Apparently buoyed by its success in ushering in the unpopular policy of increasing fuel prices, the government is preparing another politically sensitive measure -- tax amnesty -- to lure back billions of dollars, which Indonesian businesspeople reportedly transferred overseas during the height of the economic crisis in 1998.

Even the previous government of Megawati Soekarnoputri, notorious for its high tolerance of corruption, scrapped the idea of a tax amnesty, which has been aggressively promoted by the Indonesian Chamber of

Commerce and Industry (Kadin) since 2003.

Such tax relief was considered an insult to the public's sense of justice as the scheme would benefit mostly businesspeople and big tax evaders, allowing them to essentially launder their hidden assets.

However the idea has gained powerful support at the center of executive power. Former Kadin leaders' Aburizal Bakrie, the current chief economics minister, and Vice President Jusuf Kalla, were assigned by

President Susilo Bambang Yudhoyono to conduct the day-to-day management of the economy.

Aburizal even promoted the tax amnesty like a mantra that could immediately generate a one-time cash infusion of at least Rp 50 trillion (US$5.3 billion) in state revenues in return for immunity from prosecution.

Such a huge sum of additional receipts through a one-shot deal could indeed be quite tempting for the cash-strapped government.

Despite the risks of moral hazards and damaged confidence in the credibility of tax-law enforcement, the tax amnesty is not without strong rationale, especially in Indonesia where tax evasion has always been quite extensive.

Registered personal income taxpayers are still less than 2 percent of the 120 million-strong workforce. The tax ratio (tax receipts against gross domestic product) are less than 13 percent, the lowest among ASEAN countries.

The proponents of the tax amnesty have strong points to support such a program, especially now when the country is desperate for new investment to create jobs.

First, since the corruption-infested tax directorate general is unable anyway to hunt down tax evaders and recoup their hidden assets, there is no harm in offering them a one-shot amnesty if the government can get a sizable amount of additional revenues.

Second, businesspeople will not hesitate to reinvest their capital in Indonesia to expand the economy and create jobs once their previously hidden assets are declared legitimate under the amnesty program.

Third, the scheme will net a large number of new taxpayers, including small and medium-scale enterprises (SMEs), thereby broadening the tax base for future tax collection. Tax registration also will make SMEs legitimate and consequently improve their access to finance.

Fourth, as the court system in the country is both corrupt and overburdened, a tax amnesty may allow the tax administration to minimize prosecution costs.

No wonder, given these potential benefits, many countries, including dozens of developed ones, have granted such one-time tax amnesties.

But the opponents of a tax amnesty also have equally strong points against introducing such a scheme, at least until an efficient, strong tax administration system is established.

Granting an indiscriminate tax amnesty now will mostly benefit the big businesspeople, including the former bank owners, who, according to an investigative audit by the Supreme Audit Agency (BPK) in 1999, misused Rp 138.5 trillion (US$15.40 billion) of the Rp 145 trillion Bank Indonesia extended in emergency liquidity credits to help bail out the banking industry in 1998 and 1999.

It would gravely insult the public's sense of justice if those same conglomerates, who had previously been released and discharged from criminal charges related to their bad debts, were granted tax amnesty under a weak and corrupt tax administration system.

Tax amnesty is supposed to encourage people and enterprises to register as taxpayers and start completely new without fear of prosecution of their past tax debts.

But granting tax amnesty without first establishing a strong tax administration system could only be a deception to allow tycoons to launder their hidden assets, tax-evaded money.

Successful tax amnesty programs in developed and developing countries have shown that the facility should be provided through a good mechanism, and the tax amnesty period should immediately be followed by strong law enforcement against tax evaders and manipulators.

Unless carefully designed and supported with strong information infrastructure to detect future tax delinquency, a tax amnesty program could instead increase disincentives to taxpayers.

Without this prerequisite, a tax amnesty will only cause moral hazards as people, expecting another amnesty in the future, will lower their tax compliance, and honest taxpayers will be discouraged to continue voluntary compliance.

A highly successful amnesty which nets a large number of new taxpayers could even adversely affect future tax collection if the tax administration cannot devote enough resources to handle the additional workload.

There are thus both great potential benefits and big risks inherent with the granting of a tax amnesty. But it depends on the quality of the tax administration system used to implement the program.

The government certainly is facing a mountain of work preparing an overall tax reform program, and that includes the drafting of a bill on a tax amnesty.

But then as the raucous opposition to the otherwise economically rational fuel-price hikes has demonstrated, even the best program will not sell unless it is properly marketed to those who will implement it and the public who will have to accept it. In the end, it is an exercise in practical politics.

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Pertamina's cash-flow problems and domestic fuel stocks

Monday, April 18, 2005

Vincent Lingga, The Jakarta Post, Jakarta

Is the government so strapped for cash that it failed to pay Pertamina Rp 23 trillion (US$2.42 billion) in fuel subsidies for the first quarter?

"No, we are by no means facing a liquidity crisis. In fact, the state budget thus far has booked a surplus of some Rp 10 trillion," asserted State Treasury Director General Mulia P Nasution last week.

However, Pertamina spokesman Abadi Poernomo had earlier disclosed to the media that the state oil company might soon have to default on some of its $1.64 billion in trade debts if the government did not soon reimburse the subsidies Pertamina had advanced during the January-March period.

Poernomo added that banks had refused to open new letters of credit (L/C) for the company to import oil, warning that national fuel stocks could fall below the minimum buffer level of 22 days' supply.

Strangely though, Pertamina's major creditors, including Bank Mandiri, Bank BNI and Bank Rakyat Indonesia, denied that they had any credit problems with Pertamina.

Another Pertamina official, this time from its public relations department, also denied that the company's crude oil suppliers had any problems with its L/Cs.

So, why then did the state oil monopoly resorted to such damaging disclosures? Doesn't Pertamina, as a state company, realize that such statements could jeopardize its own creditworthiness and even heighten the government's sovereign risk?

The fact is, however, a threat of fuel shortages always works wonders for Pertamina in collecting from the government.

The latest case occurred early last week when the government rushed to pay the company Rp 4.1 trillion (US$431 million) to provide it with access to a new credit line.

The payment was made one day after Pertamina warned through the media that the country might face a severe fuel shortage in May or June if the government did not reimburse the company for the overdue fuel subsidies.

The issue centered around the mechanism by which the government pays domestic fuel subsidies in respect of the difference between the prices at which Pertamina is required to sell fuels and their actual production costs.

Until mid-2004, the government reimbursed Pertamina for the subsidies that the company had advanced only after the Supreme Audit Agency or the government comptroller had audited Pertamina's domestic fuel sales accounts.

The audit requirement was deemed necessary to ensure that the amounts claimed by Pertamina in respect of the fuel subsidies were reasonable, given the company's reputation as a notorious "den of rent-seekers". Past experience also shows that quite a large proportion of subsidized fuels ends up being sold to industrial users or being smuggled overseas.

A consequence of this is that the reimbursement process often takes several months. But this was not too much of a problem in the past for the state oil monopoly as oil prices until the end of 2003 mostly averaged below $30/barrel.

However, with oil prices rising steeply since early 2004, domestic fuel subsidies have increased so sharply that Pertamina's cash-flow situation no longer allows it to give the government credit for the fuel subsidies for more than one month.

The finance minister therefore decided in mid-2004 to expedite the reimbursement process by making monthly payments of 90 percent of the subsidies paid by Pertamina if oil prices averaged below $33/bbl and 95 percent if oil prices exceeded $33/bbl. Reimbursement no longer requires an audit, but only verification.

Under this arrangement, only between 5 percent and 10 percent of actual fuel subsidy spending is subject to independent auditing, a process that takes several months. The government, for example, has yet to reimburse Pertamina for Rp 3.87 trillion in subsidy spending for the last quarter of 2004, pending the completion of an audit.

The problem, however, is that since early this year oil prices have been hovering above $45/bbl and monthly fuel subsidy spending has not been about Rp 3.3 trillion as the government had estimated for the whole year, but will reach as high as Rp 8 trillion.

Pertamina says that it needs at least $800 million a month for oil imports, which now account for almost one third of daily domestic consumption of about 178,000 kiloliters, if oil prices remain in excess of $45/bbl.

As Minister of Energy and Mineral Resources Purnomo Yusgiantoro revealed last week, the government had not reimbursed Pertamina for about Rp 23 trillion in fuel subsidies that the company had advanced in the January-March period.

Even though Pertamina has said its cash-flow situation was no longer adverse after the Rp 4.1 trillion payment made early last week, and the issue seems to have disappeared from the media radar screen, the tussle over the mechanism for fuel-subsidy reimbursement still leaves some worrisome questions.

If the government is not facing a liquidity problem, as Treasury Director General Mulia P Nasution asserted, why was it so seemingly unaware of Pertamina's cash flow situation that it fell behind in its payments to the company.

One may also question the true state of Pertamina's credit standing with oil suppliers overseas, such as Aramco, from which the state monopoly has been buying crude since the late 1970s. Why is Pertamina, given its position as an oil monopoly, state-owned company and an established, bulk buyer, unable to get trade credit of three months from its crude suppliers?

Without a better reimbursement mechanism, similar problems could recur, and Pertamina might once again resort to threats and brinkmanship in its dealings with the government.

But whatever the new mechanism Pertamina and the government decide on, it must not jeopardize the company's cash flow situation while at the same time ensuring that the amount of Pertamina subsidy spending that is reimbursed is really based on actual fuel sales to eligible consumers.