Condition critical: Economic reforms cannot wait

Monday, March 12, 2007 Vincent Lingga, The Jakarta Post, Jakarta

Reform is never easy when it requires changes to an entrenched economic system. That is why broad-based reforms often require a crisis or perception of crisis, or at least a sense of chronic deterioration. It was economic crisis that brought down Soeharto in May 1998 and ushered in the reform era.

And we are once again mired in a critical condition now, despite the macroeconomic stability the government often boasts of.

With unemployment and underemployment estimated at some 40 million and the number people living on less than US$2/day exceeding 100 million, our situation is clearly critical.
But both the government and the House of Representatives have yet to demonstrate a sense of crisis in accelerating the reform measures sorely needed to reinvigorate investment, generate jobs and lift people out of poverty.

We had expected good sense to prevail in the end, but the Susilo Bambang Yudhoyono administration, currently in the middle of its term, has yet to demonstrate a feeling of urgency toward policy reforms in priority areas.

The experiences of other countries that have been successful in pushing through broad reforms shows that the timing of reform depends on political leadership - the leadership to make it clear that there is a crisis.

The government moved decisively in October, 2005 to reform the energy sector by slashing fuel subsidies through a 125 percent increase in fuel prices after the rupiah had come under fierce attacks by speculators.

This move immediately gained rewards from the market in the form of confidence in the rupiah and has substantially increased the government's fiscal capacity.

But it is rather mind-boggling to notice how apparently ignorant the government and politicians at the House have been for not being able to identify the crisis conditions that should have forced them to accelerate reforms.

Look how deliberations of the taxation, labor, investment and mining bills, already several years behind schedule, have been protracted, stuck on issues that are not very important to stimulating economic efficiency. Likewise, reform in public administration, including local governments and state companies , has been quite slow.

The challenges lie on two fronts. While the pace of reform legislation has been much slower than expected, the implementation of reform measures is even more disappointing. The cascading impact of this delay is a disappointingly slow recovery in public and private investments.

The government was commended for the comprehensive reform packages in infrastructure and investment it launched in the first quarter of last year. However, their implementation has dragged.

The crash program to construct 10,000 megawatts in additional power generation capacity seems to have crashed amid bickering about tender procedures and allegations of corruption.

The negative impact of the slow pace of reform is already being felt in the quality of growth as the number of jobs created by one unit of economic growth is now much smaller than before 2000.

The steady rise in unit labor costs in excess of productivity and rigid labor regulations have prompted new investors to economize on labor by avoiding labor-intensive businesses.
Banks, whose function is supposed to center on lending, prefer plowing their funds into debt instruments that have nothing to do with financing real economic activities.

Inefficiency and rampant corruption within the public sector, notably in tax, customs and business licensing, remain the most serious obstacles to new investment and the main source of business risk.

We often fail to realize that besides legal uncertainty, which makes it extremely difficult to do a reasonable risk calculation, corruption is also a source of unpredictability because any deal could be undone by someone bribing someone in the government.

President Yudhoyono received a strong political mandate in 2004 from disillusioned people who want things to change, but he seems unable to show the leadership necessary to translate this broad dissatisfaction into concrete action and move things in the direction the people want.

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Idle funds threaten macroeconomic stability

Wednesday, March 07, 2007 Vincent Lingga, The Jakarta Post, Jakarta

The banks will publish their audited financial statements for 2006 within the next few weeks. The statements will mostly show bigger profits, but that doesn't mean the banks' managements should be commended for jobs well done.

The credit should instead go to Bank Indonesia, the nation's central bank, which had "been forced" to contribute more to banks' earnings.

Bank Indonesia Governor Burhanuddin Abdullah should indeed feel frustrated, since the new package of regulations he issued early last year to encourage bank lending has turned out to be ineffective. He should now work harder to soak up excess liquidity by issuing more Bank Indonesia Certificates (SBIs) and paying quite dearly for this instrument.

Even though many businesses are starved of finances, most major banks still prefer investing their excess funds in debt market instruments, notably risk-free SBIs and government bonds, instead of pumping them into the real economy.

It is unusual for a central bank governor to be so straightforward in airing a pessimistic outlook. But that was what Burhanuddin did last week. Apparently fed up with the slowness of the government's implementation of its reform policies, he sounded the alarm bell, warning of a weaker economy if banks remain inordinately risk-averse in their lending operations.

It is indeed a frustrating job for the central bank governor because, the more banks invest in SBIs, the higher the cost of Bank Indonesia's monetary market operations. He estimated the interest costs of SBIs this year alone at Rp 25 trillion.

While major banks pay only between seven to eight percent interest on time deposits, SBIs pay 9.25 percent. No wonder banks prefer investing their funds in SBIs. They can get more than 1.25 percentage points in interest revenue without doing anything. But investing in SBIs contributes nothing to economic growth.

As of last month, outstanding SBIs totaled almost Rp 240 trillion (US$25.8 billion). Burhanuddin estimated this amount could increase to over Rp 300 trillion by later this year if bank lending did not expand significantly.

The central bank governor certainly realized he could not jawbone commercial banks to expand their lending if business risks remain high and the overall investment climate remains highly adverse. Even the reduction of the central bank's benchmark short-term interest rate to 9 percent Tuesday will not be effective in prompting more lending.

It would be a suicide for banks to aggressively lend to businesses with unusually high risks, especially now the central bank is imposing higher standards of capital and overall credit risk management.

There is no a panacea to stimulate credit expansion. Bank lending cannot be accelerated by decree. The most effective way to stimulate bank lending is to improve the overall investment climate. Without significant improvements in the business climate the risk of bank credits turning sour will remain high.

Excess liquidity at banks is inflicting another cost on the economy. The huge sum of funds invested in SBIs and government bonds impose risks on macroeconomic stability. This is because idle money can immediately be used as ammunition for speculative attacks on the rupiah in the foreign exchange market.

Even more worrisome is the fact that, due to the unfavorable business climate, most foreign investment entering the country now consists of short-term portfolio capital. This hot money, currently estimated at nearly Rp 590 trillion, including Rp 505 trillion in stock holdings, Rp 55.5 trillion in government bonds and nearly Rp 25 trillion in SBIs, is another source of ammunition for speculative trading on the foreign exchange and stock markets.

The 3.5 percent decline in the Jakarta stock market composite index Monday had nothing to do with Indonesian economic fundamentals. The fall was due to changes in foreign investor sentiment caused by a perceived increase in the downside risk of the U.S. economy and a possible rise in Japan's interest rate.

This development is just more evidence that Indonesia's financial market and rupiah have become highly vulnerable to speculative attacks. This has been due to the steady increase in the amount of excess liquidity at the banks and in foreign portfolio capital inflows.

It should be needless to remind the government that the most effective way to push this excess liquidity into the real economy -- where it can finance the construction of factories and infrastructure -- is to reduce the country's high business risk by passing more reforms.

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Let us cheer, not fear, the arrival of foreign banks

Wednesday, February 28, 2007 Vincent Lingga, The Jakarta Post, Jakarta

The dilution of the deposit insurance scheme to a maximum of Rp 100 million (US$10,500) per account next month will unleash stronger market forces to screen banks, as depositors will have to be more careful about choosing the financial institutions they deal with.

Depositors with savings of up to Rp 2 billion have often been influenced more by the level of interest rates or the location of the bank than the soundness of the financial institution. They can rest assured that whatever may happen to the bank, all their savings will be reimbursed by the government.

This narrower deposit-guarantee program and the higher capital standards -- minimum capital of Rp 80 billion this year and Rp 100 billion by 2010 -- as well as the tougher risk management imposed by Bank Indonesia will certainly speed up the consolidation of the banking industry.

Obviously, the consolidation process will reduce the number of banks, now around 130, either through mergers or acquisitions. If last year is any guide, more local banks will be acquired by foreign investors. Last year foreign investors bought seven small banks.

This trend will undoubtedly heighten the concerns about increasing foreign domination of the banking industry, whipping up nationalist sentiments against what is seen as outside control of a vital service industry.

However, there is nothing much to worry about, because the foreign banks must still operate by the rules of the central bank, Bank Indonesia.

Higher foreign investor interest in the financial services industry should instead be welcomed as a vote of confidence in the long-term outlook of Indonesia's economy. Foreign investors would not be willing to stake out more capital in the financial sector if the economic outlook were poor. The financial services industry can grow soundly only in an expanding economy.

Even more important, the experiences of most other countries have proven the great benefits of the entry of major international banks to the development of a sound domestic financial industry. Banks are the heart that pumps oxygen and lifeblood throughout the economy.

Strategic investors with good reputations will accelerate the operational restructuring of banks as they bring in expertise, technology, credibility and better risk management.

Look at how all the big nationalized banks -- Bank BCA, Bank Niaga, Bank Danamon, Bank International Indonesia, Bank Lippo and Bank Permata -- which were acquired by investors from the U.S., Singapore, Malaysia, South Korea, Germany and Britain, have improved by strengthening their governance. On the other side, state banks such as Bank Mandiri and Bank BNI are still struggling with large amounts of non-performing loans and remain vulnerable to interference from politicians and senior officials.

A bank is not just a business entity in the ordinary sense, given its fiduciary responsibility, the multiplicity of transactions it does and its key function within the economy.

That is why the principles for good corporate governance for banks are much more comprehensive than those for other commercial entities. Good governance and corporate responsibility are prerequisites for the integrity and credibility of market institutions.

For that reason, not everybody who has tons of money can have controlling ownership of a bank. Those who want to become majority owners and commissioners have to pass the central bank's fit-and-proper test to assess their technical competence and integrity.

Because of their special role, banks are put under a multi-layer supervisory mechanism. Banks are an institution of trust, and the domestic banking industry, which collapsed in 1998 under bad governance practices, badly needs to regain the public's full trust.

Foreign banks, which together now control almost 50 percent of the banking industry's assets, can help accelerate reforms in risk management, corporate governance and competitiveness. In return, these foreign players can tap the attractive growth opportunities the country offers.

Regardless of ownership issues, however, the most important step of all is for the Finance Ministry and Bank Indonesia to focus on further strengthening the systems that supervise and regulate the financial services industry.

MEET THE READERS: Fauzi Ichsan (center), a senior economist with Standard Chartered Bank, speaks Wednesday at a readers' gathering of The Jakarta Post, as BCA commissioner Cyrillius Herinowo (right) looks on. The event, moderated by the Post's senior editor Vincent Lingga and titled "An Evening with the Post: Fear of Foreign Banks Domination: Justified or Misguided?" was held at Blow Fish Cafe in Mulia Tower, Jakarta. (JP/J. Adiguna)

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State minister dreams of cutting the number of SOEs

Monday, February 26, 2007 Vincent Lingga, The Jakarta Post, Jakarta

Judging by the government's privatization record over the past three years, the plan revealed by State Minister for State Enterprises Sugiharto last week to slash the number of state companies from almost 140 to 69 within three years is something of a pipe dream.

Sugiharto has never been able to meet the privatization target set in the annual state budget, let alone coming plans that have yet to be consulted with various ministries, the House and other stakeholders, including trade unions at state companies.

It was almost two years ago that Sugiharto launched a blueprint on the reform of state enterprises through mergers, divestments or outright liquidations, but nothing seems to have come of it.

Until last week, that is, when he suddenly came out with an ambitious target for government divestments -- plans to reduce the number of state companies by 37 this year, by 15 in 2008 and by 18 in 2009, while only one state company (PT Perusahaan Gas Negara) had been privatized over the past two years.

Even this gas company's initial public offering last year was fraught with allegations of insider trading and inadequate disclosure regarding income projection.

No one disagrees with the rationale behind the reform program. There are simply too many state companies. The government really does not have any reason to involve itself in so many different businesses that could be run efficiently by private firms.

The blunt fact is that most state companies have been grossly inefficient, with lax internal controls, poor accounting standards and practices and are highly vulnerable to arbitrary government interference. No wonder, as latest financial reports have shown, most state companies are less profitable than their private-sector competitors, and more than one-fifth of them are losing money.

However, not a single one of the successive governments over the past ten years has demonstrated any sense of urgency to reform state companies -- through privatization, mergers or liquidation -- not even during the height of the economic crisis from 1998 to 2002, when the government was having a severe liquidity crisis.

Every time a new government comes to power, it claims the reform of state companies is one of its top priorities, fully aware of the great benefits of privatization. But the promise is soon forgotten, and it is back to business as usual for officials and politicians -- retaining state enterprises as their cash cows.

The target set by Sugiharto is even more unfeasible because as, the minister himself said, the privatization, merger or liquidation plan will have to go through a complex process of consultations with the various technical ministries and the House of Representatives, as well as other stakeholders, such as employees.

True, privatization is fundamentally a political transformation and an uphill task for that matter, as it exacts a major change in the government's role in the economy and in society as a whole.However, there is no reason why every government divestment plan should be approved by all stakeholders, as long as its process is transparent and accountable according to the step-by-step procedures already agreed on by the inter-ministerial Privatization Committee and the House of Representatives.

Requiring the approval or support of so many different ministries and trade unions will only make the program vulnerable to sabotage by vested-interest groups bent on maintain state enterprises for their own financial benefit.

What is urgently needed is a broad legal and political framework for the reform program and clear-cut guidelines on which companies would be best privatized through the stock market, which through strategic sales (private placement) and which ones should be merged or liquidated.

This framework should be supplemented with standard operational procedures to secure transparency and accountability and to close any loopholes that may still be exploited by corrupt officials.

Admittedly, privatization, like other reform measures, may initially cause destabilizing impacts as redundant employees and complacent managers in inefficient companies are afraid of losing jobs, and many senior officials with political power over state enterprises are worried about losing their money trees.

This is where the executive leadership is needed to enlighten all the stakeholders of the benefits of the reform of state companies to the national economy. This is also the reason why we are pessimistic about Sugiharto's ambitious program, as the present government rarely demonstrates its leadership when it is needed to generate optimism and market confidence

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