US-based watchdog Human Rights Watch (HRW) said graft at every level of the country's logging industry had to be overcome before investors could have any confidence in proposed carbon credits linked to protected forests.

Between 2003 and 2006, annual revenue lost to mismanagement and corruption in the timber industry was equal to total public health spending at all levels of government, it said.

"In recent years almost half of all Indonesian timber has been logged illegally at a staggering cost to the Indonesian economy and public welfare," said the report entitled "Wild Money: The Human Rights Consequences of Illegal Logging and Corruption in Indonesia's Forestry Sector".

"Corruption and untransparent, unaccountable revenue flows in Indonesia are so widespread that a new expression has come into common usage in the Indonesian language for such uncontrolled funds, 'wild money' (dana liar)."

The unreliability of government figures on forest management and the routine falsification of wood harvest reports pose major obstacles to Indonesia's plans to link its forests to international carbon markets, it said.

A UN-backed scheme that will be on the table at the UN climate summit in Copenhagen later this month would see rich countries pay developing countries like Indonesia to preserve the carbon locked in their forests.

The Reducing Emissions from Deforestation and Forest Degradation in Developing Countries (REDD) scheme envisages a global market where polluters offset their emissions by buying credits for carbon saved in protected forests.

As much as 20 percent of global carbon dioxide emissions, which contribute to climate change, are estimated to come from forest destruction.

"Pressure to address climate change has created a booming interest ... in markets to offset carbon emissions through direct payments to countries like Indonesia, whose extensive but endangered forests act as carbon sinks," HRW said.

"Without dramatic improvements in the governance of Indonesia's timber sector ... investors can have no confidence that the offset payments will in fact go to the preservation of forests as a means to avoid carbon emissions rather than to further fund a deeply mismanaged and corrupt system."

Australia is at the forefront of efforts to establish the workability of such a scheme and is funding one of the world's biggest REDD pilot projects in Indonesia's Kalimantan region.

Some environmental activists however say REDD will not reduce global carbon emissions and threatens to destabilise carbon markets with a flood of cheap and dubious credits.

"Inadequate oversight and conflicts of interest raise a red flag over whether Indonesia can become a reliable carbon-trading partner," HRW deputy programme director Joseph Saunders told reporters in Jakarta.

"The partners must ensure that a rigorous, transparent and enforceable tracking system is in place before financing projects ... (otherwise) you risk exacerbating the problem.

"Until the lack of oversight and transparency are taken seriously, pouring more money into the leaky system from carbon trading is likely to make the problem worse, not better."

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