Bill Guerin, Jakarta – Publicly listed state-owned pharmaceutical giant Indofarma is in the public eye over its miraculous transformation of a reported Rp88.6 billion profit in the first three quarters of 2002 into a net loss of more than Rp20 billion (US$2.3 million) by the end of the year.
Though rumors had been rife for some time that all was not well at Indonesia's second-biggest pharmaceutical company, few had any idea of the sheer scale of the financial irregularities that have, to all intents and purposes, deceived the market, potential investors and the public.
On Friday Indofarma held a public presentation to disclose its unaudited report after the Jakarta Stock Exchange (JSX) decision to suspend trading of the company's shares because it had not handed over its 2002 financial report to the Capital Market Supervisory Agency (Bapepam) and the JSX itself.
Indofarma president Edy Pramono and financial director Purwo Kartiko told the press that mistakes in the inventory during the first three quarters and the need to dish out massive discounts to pharmacies had contributed to more than Rp108.6 billion in discrepancies in the fourth quarter.
Pramono has presided over a major enterprise whose standards of accounting and common sense can scarcely be credited. A Rp57 billion ($6.5 million) discrepancy in the stock inventory was hardly surprising given that Indofarma admitted it did a full inventory only once a year.
The practice of calculating the basic cost of goods based on prices established at the beginning of the year and then applying them only at the end of the year when the inventory was taken threw up the startling gap between the net profit of Rp15.92 billion in the first quarter of 2002 and the real figure of Rp6.61 billion after adjustment for increases in the cost of goods sustained over the full year.
Pramono went into even greater detail for the benefit of reporters. The announced operating profit of Rp26.72 billion should have read Rp12.78 billion, though sales remained unchanged at Rp119.07 billion, he said. In the second quarter of 2002, though sales of Rp267.73 billion were a true figure, the net profit reported of Rp45.31 billion was, in fact, a net loss of Rp12.62 billion, just as the initial operating profit figure of Rp69.03 billion was actually a net loss of Rp9.20 billion. Sales of Rp444.08 billion in the third quarter were a real figure but the Rp88.57 billion net profit reported was, in fact, a loss of Rp1.41 billion and operating profit of Rp134.32 billion should have read only Rp17.10 billion.
The scandal, just beginning to gather steam, is acutely embarrassing for a government that was ready last year to divest a majority of its 81 percent stake in Indofarma and maintain majority control of government-owned pharmaceutical stablemate Kimia Farma.
The government has marked Indofarma for privatization throughout the past two years, but hit repeated snags from unfavorable market conditions and political interference.
Last May investor interest had been whetted by a 56.5 percent jump in Indofarma's net profits in the first quarter, to Rp15.92 billion. Potential buyer Dutch pharmaceutical and health-care-products giant Nutricia International BV wanted a cast-iron agreement from the government allowing them to continue to produce generic medicines for the public in the event of a deal being reached on the majority takeover.
This was quickly followed by an about-turn by the government, which backed a new strategy, said to have been proposed by Health Minister Ahmad Sujudi, that resulted in a revised decision to divest only a minority stake in Indofarma, because of its role as the primary supplier of cheap generic drugs to the general public and government health-care centers (puskesmas).
Stablemate and rival, state-owned Kimia Farma, the largest pharmaceutical manufacturer in the country, also withdrew from a plan to set up a joint-venture company with the German STADA Arzneimittel AG to sell generic drugs in Indonesia because of uncertainty over the privatization strategy.
While all this was going on, Indofarma was fighting off stiff competition brought on by the relatively small market size, complex import clearance procedures for raw materials and the intrinsic weakness of the Indonesian rupiah against the dollar.
A subsidiary, PT Indofarma Global Medika (IGM), which distributes the generic medicines, caused Rp71.03 billion of the shortfall through the need for heavy discounting of these products, according to Pramono.
Corrupt customs officials make it difficult even for state-owned enterprises to import drugs legally and are also responsible for the flood of illegal and fake medicines on the market in Indonesia. The local industry remains severely threatened by these cheaper, smuggled and fake products, which have flooded the market since 1998. Bribes to customs officials smooth the path, and even machinery and raw materials needed to counterfeit medicines have been found in the country.
The dependency of the pharmaceutical industry on imported raw materials makes it extremely vulnerable to the fluctuation of the rupiah against the US dollar. With so much of their raw materials imported, and paid for in dollars, local producers find it well nigh impossible to reduce production costs and the price of the products.
In 1998, the cost of producing drugs more than doubled and retail drug prices were up by more than 400 percent. The rupiah lost nearly 80 percent of its 1997 value, precipitating a crisis in the health system. The government was forced to give subsidies on pharmaceutical raw materials. By 2001 Sampurno, head of the powerful Food and Drug Supervisory Board (BPOM) that approves licenses for medicines and foodstuffs, and one of Indofarma's commissioners, tried but failed to get a protectionist deal for Indofarma that would allow it to produce and distribute no fewer than 20 medicines.
The rationale was that efficient production methods would be able to reduce prices of the drugs by 50-60 percent, but other pharmaceutical companies, both state-owned and privately owned, lobbied for the withdrawal of the plan.
Only three months ago Pramono had pleaded with the government to allow it to raise the prices of its generic medicines, the prices of which are set by the government for the official market, as the company had been hit by rising production costs. He said an alternative would be to exempt the company from paying 10 percent value-added tax (VAT).
Neither request was granted, and yet barely a mile as the crow flies from Indofarma's administrative headquarters in Central Jakarta is the Pramuka market, where all manner of branded and generic drugs as well as hospital consumables and prescription drugs are sold at very competitive prices.
Indofarma's hospital and pharmacy customers have no need to pay Indofarma prices, at least those who have businesses in metropolitan Jakarta. Neither do they need to hold substantial stocks as, with the exception of a few imported drugs that are scarce on the market, Pramuka merchants hold wholesale levels of stocks themselves.
Sales tax on Indofarma's products leaped from 27 percent to 43 percent last year, causing a Rp16.60 billion loss in terms of net sales on their sales mix of roughly 80 percent generic drugs and 20 percent brand-name drugs. Indonesia's No 2 drug maker is a massive operation with 28 branches across Indonesia. It produces about 4.5 billion generic tablets every year together with supplementary health-care products and patented herbal medicine potions. It is against this background that Indofarma's need, and ability, to turn a profit needs to be seen and the pressures generated on staff and management, who are not the industry's best, understood.
Anthony Sunarjo, chairman of the Indonesian Pharmaceutical Federation (GPFI), says there are currently some 160 pharmaceutical companies operating in Indonesia, 38 of which are owned by foreign companies, and none of which have a market share of above 10 percent. An estimated 1,500 distributors, 6,500 dispensaries and 5,000 drugstores form the infrastructure that gets the medicines to the public. Indofarma and Kimia Farma cover the whole country through a branch network, though the latter has the edge with its ability to sell directly to the consumer through its chain of pharmacies.
GPFI estimates there are also upwards of 100,000 traders operating illegally in a market whose value is essentially the same as Thailand and the Philippines, about $1.5 billion a year.
The rub is that Indonesia has the lowest consumption of drugs per head of the three countries. In 2002 Indonesia, with a population of 210 million, spent only $7.10 a head, up from US$4 in 2000, as against Thailand's $23.80 a head with a population of 63 million and the Philippines consumption of $19.20 per head in a population of 78 million.
The fallen star will now be placed under a special restructuring program, according to the Ministry of State Owned Enterprises, which controls the privatization program. A similar fate awaits Kimia Farma.
Pramono succeeded Gunawan Pranoto as president director. The latter has substantial political clout, and the health minister himself appointed Pranoto to head up Kimia Farma. The two pharmaceutical giants were among four state companies scheduled for sale last year as part of the privatization program. The selloffs, together with those of Bank Mandiri, the country's largest bank, and Angkasa Pura II, which controls Jakarta's international airport, were moved back to this year because of various technical problems.
The sales of Indofarma and Kimia Farma were included in successive Letters of Intent (LoIs) signed by the International Monetary Fund and the government, though this is no longer a constraint given Indonesia's intention to pull out of the IMF support program.
In March, when pleading for special help for the company, Pramono also criticized the government for dragging its feet on the divestment, and said Indofarma expected the government to fix a definite schedule for the privatization because if it continued to postpone the program, it would discourage foreign investors.
"I have met several officials from the Ministry of State Enterprises and I have urged them to give us an assurance on the divestment plan. The uncertainty would surely have a negative impact on our investment climate," said Pramono.
Though Pramono this week said he was ready to be replaced should any "error" on the part of management be identified, the fact that these gross irregularities took place under his watch, and in effect scuttled the chances of even a remote interest from investors, will haunt him for years to come.
Possible sanctions against the management and more independent audits of the company's books seem likely, and some local brokers say they are getting ready to ditch Indofarma stocks in the light of the inevitable public scrutiny.
The Indofarma debacle will have strengthened the arm of those legislators pressing for the privatization program to be deferred until at least after next year's elections, arguing that selling national assets in such an unfavorable investment climate would be folly.