The Asian financial crisis led to a major devaluation of the Indonesian exchange rate,macro instability, and the need for a “structural adjustment” program. The real devaluation affectsprices throughout the economy and has a major impact on growth, production, deforestation, andincome distribution in the Sumatera region. This paper uses computable general equilibrium(CGE) models —a national model and a regional model of Sumatera— that focus on agricultureto explore the impact of a real devaluation on the economy of Sumatera. The model incorporatescommodity and factor market linkages between Sumatera, the rest of Indonesia, and the world(through commodity trade). Simulations are conducted for the short and medium run underalternative scenarios of macro adjustment.Structural adjustment causes Sumatera's economy to contract in both the short andmedium run. Devaluation leads to increases in the prices of tradable goods. Regional exportsincrease, mainly from the non-agricultural sectors, and imports decline. The agricultural terms oftrade (agricultural prices relative to non-agricultural prices) decline because agriculture has asmall share in both regional and national exports. Food crops, except for rice and sugar, declinewhile tree crops increase. Deforestation is likely to increase because demand for forestry productsincreases, both as final products and as intermediate goods for the wood processing industry, bothof which are sold on international markets. We analyze a possible policy response of imposing anexport tax of 5-20 percent on processed wood to discourage further deforestation in the region.The results show that the proposed export tax reduces production of raw timber and processedwood, but at the cost of lowering exports and hence making the macro adjustment more difficult.Given the current situation, it is impossible to predict exactly how the resolution of thecurrent macro crisis will unfold. We model two alternative macro adjustment scenarios thatshould bracket the likely response of the Sumatera region to the devaluation and structuraladjustment program. In the first, we assume that regional investment is a proportion of regionalaggregate income (or regional absorption), and that the adjustment burden is sharedproportionately between aggregate consumption and investment. In the second, regional savingsand investment are assumed to fall more, as the region’s trade balance is forced to improvedramatically to reflect the large required changes in the national trade balance. Under the firstadjustment scenario, a devaluation benefits large farm households in the rural area and urban highincome households who are involved in the production of tradable goods, while both rural poorand urban poor households lose. When investment falls more, all farm households and urban highincome households benefit, but poor urban households lose more because the decline ininvestment hurts unskilled urban labor, especially in construction.
