Centralizing investment licensing a bad idea

Monday, April 02, 2007 Vincent Lingga, The Jakarta Post, Jakarta

Then president Megawati Soekarnoputri tried to centralize the licensing of foreign and domestic investment in the Investment Coordinating Board (BKPM) in 2004, but failed because of the strong bureaucratic jealousy between government institutions.

Going off in a strikingly different direction, President Susilo Bambang Yudhoyono announced plans in May 2005 to dilute the function of the BKPM into simply a promotion and company registry office, and to decentralize investment licensing in the spirit of local autonomy.

But except for putting the BKPM under the jurisdiction of the Trade Ministry, no other concrete measures have been taken to follow up on that idea.

The new investment law that was enacted by the House of Representatives on Thursday seeks not only to upgrade and strengthen the status of the BKPM, but also to centralize investment licensing at this agency under the concept of a one-stop investment licensing and service center.

However, the articles in the new law regarding the delegation to the BKPM of licensing authority by the various ministries and regional administrations are so ambiguous that past mistakes could be repeated, with investors again finding themselves stuck in a bureaucratic maze.

The law stipulates that the investment board shall be led by an official with ministerial status who is responsible directly to the president. This is, to a certain extent, similar to the BKPM's status under Soeharto's authoritarian administration. During the New Order, the investment board was considered a non-ministerial government institution under the oversight of the President's Operation Offices (State Secretariat).

However, the law also states in another article that the BKPM, in executing its function as a one-stop licensing and service center, shall involve direct representatives from related ministries and regional administrations.

This means that all ministries, government agencies and regional administrations related to the licenses/permits and services/facilities needed by investors should assign representatives to the BKPM.

Hence, the investment board will have officials from Manpower and Transmigration Ministry for processing work permits for expatriates, from the Justice and Human Rights Ministry for residency permits and entry visas, the Finance Ministry for granting tax and import duty incentives, etc., etc.

This could be the trap that makes the concept of the one-stop licensing and service center unworkable, because the law does not explicitly require the various ministries and regional administrations to transfer their licensing authority fully to the BKPM.

The new provisions will only spare investors the arduous procedures that require them to go from one ministry to another, from one regional administration to another, to obtain the various permits or facilities needed for their investment projects. Investors need only to file their applications with the BKPM, which is responsible, on behalf of the investors, for obtaining the necessary permits or facilities from the relevant ministries.

But inter-ministerial coordination has always been the weakest point of the government. Even the authoritarian, centralized administration of Soeharto took almost 15 years to make the BKPM a one-stop administrative center for investors. But this facility broke down soon after Soeharto's fall.

The reason behind the extreme difficulties in inter-ministerial coordination is not only the pervasive bureaucratic jealousy. From the perspective of public administration, seen as one of the most corrupt in the world, licensing authority means money for officials.

Centralizing investment licensing at the BKPM could also generate a hostile bureaucratic climate for investment ventures in the regions, and this will sabotage one of the primary objectives of local autonomy -- to encourage regional administrations to compete for investment.

The central government should instead delegate most of its licensing authority to regional administrations, with the BKPM retaining authority only for those requirements that need national standards, such as the environmental impact analysis, tax incentives, etc.

Instead of centralizing the overall investment licensing in Jakarta, which is after all contrary to the spirit of local autonomy, the government should help empower regional investment offices -- Provincial Investment Coordinating Offices (BKPMD) -- to enable them to better serve businesses and woo new investors through business-friendly policies.

Many local administrations still don't fully realize the great contribution of investment to their local economies through job creation and the injection of purchasing power to fuel consumer demand, thereby generating growth in the manufacturing industry.

Investors need expedient procedures for obtaining all the permits and facilities needed for their ventures, but the method of addressing this need should not kill the incentive for regional administrations to compete with each other in wooing domestic and foreign investment.

However, there are still escape clauses in the law that can help the government avoid past mistakes regarding the BKPM and the bureaucratic machinery for investment licensing.

The new investment law, which will replace the 1967 Foreign Investment Law and the 1968 Domestic Investment Law, stipulates that technical details on the implementation of the one-stop licensing and service center for investors, and on the division of public administration authority in the management of investment, shall be governed by presidential regulations.

Hence, like most other laws in the country, the key to the efficacy of the new investment law will depend on the provisions in the presidential regulations which, according to Trade Minister Mari Elka Pangestu, will be issued.

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Is central bank really monitoring foreign exchange?

Friday, March 23, 2007 Vincent Lingga, The Jakarta Post, Jakarta

We now worryingly doubt Bank Indonesia's capability to monitor foreign exchange (forex) flows to and from the country.

This doubt arose after the recent disclosure of state-owned Bank Negara Indonesia (BNI)'s failure to report to the central bank the transfer of over US$10 million of Hutomo "Tommy" Mandala Putra Soeharto's money from the London branch of BNP Paribas to Indonesia through the BNI Tebet, South Jakarta, branch office, in June, 2005.

Yet more confusing are the remarks made by Bank Indonesia's executives about the transaction, as quoted by Koran Tempo in its March 21 issue.

Bank Indonesia spokesperson Filianingsih Hendarta was quoted as saying that Bank BNI might consider it unnecessary to report the money transfer to the central bank because there might have been nothing suspicious about the transaction.

One found it too flabbergasting that Filianingsih seemed entirely unaware of a ruling issued by Bank Indonesia in March 2000 that required bank customers in Indonesia, including foreigners holding stay permits and Indonesians residing overseas, to submit to the central bank, through their banks, detailed reports on every foreign exchange transaction in excess of US$10,000.

The Bank Indonesia ruling, which enforces the 1999 Foreign Exchange Flow Law, also requires that such reports disclose the remitter and recipient of funds, the type and purpose of the transaction and financial relationships between the transactors.

The explanation given by Wimboh Santoso of Bank Indonesia's directorate for banking development to the same newspaper is even more dumbfounding.

Santoso said banks were not required to report any financial transactions to the central bank but should report suspicious transactions to Indonesia's financial intelligence unit or the Financial Transaction and Report Analysis Center (PPATK).

The compulsory reporting on forex transactions was designed to keep Bank Indonesia apprised of capital flow to and from the country and to enable it to implement a more effective monetary policy.

Banks are obliged to keep detailed accounts of forex transactions they conclude for themselves and their customers because they have to submit a monthly report on their forex deals to the central bank.

Indonesia has held firmly to the regime of open capital account that allows free flow of foreign exchange to and into the country.

However, the financial crisis that set off massive runs on the rupiah and a massive capital flight out of the country between mid-1997 and 1998 made the government suddenly aware of the need to make sure the monetary authority was kept posted on foreign exchange flows.

During that crisis the central bank was completely in the dark about foreign exchange flows.
Hence, the birth of the 1999 foreign exchange flow Law. Up-to-date reporting provides the central bank with accurate, comprehensive and timely data on forex deals to enable it to have a better view of the position of the external balance and to anticipate speculative attacks on the rupiah.

The March 2000 ruling was supplemented with another Bank Indonesia regulation in July 2005, which limits foreign exchange derivative transactions with foreign counterparts against the rupiah to a maximum $1 million, down from a previous total of $3 million, and caps dollar purchases in outright forward transactions and swaps at $1 million.

The foreign exchange policy measure also imposes a three-month minimum investment hedging period on foreign exchange transactions. This means that investors with underlying investments in Indonesia must keep their funds in the country for at least three months.

The question is, though, how could Bank Indonesia ensure the proper implementation of the latter ruling on such complex forex deals if it miserably failed to detect even such a simple transaction as the $10 million transfer through the Bank BNI Tebet branch?

The central bank also seemed unable to properly enforce a regulation that requires commercial banks to know their customers with regards to detecting suspicious transactions.

The fact that Tommy's money was transferred not to his own account, nor to the account of a company he owned, but to an account in the name of a directorate general at the Justice and Human Rights Ministry meant that BNI completely ignored the "know-your customer" regulation. This also violated the provisions of the 2002 Anti Money Laundering Law that called for tough scrutiny of suspicious transactions.

The BNI should have been suspicious about the transfer and should have reported it to the PPATK because the transfer "looked strange" and was not supported by any underlying transactions.

The transfer should have caused BNI executives to ask what was the business of the Justice and Human Rights Ministry with the BNP Paribas branch in London.

The BNI cannot hide behind the banking secrecy clause for its failure to report to Bank Indonesia the transfer of Tommy's money and to inform the Indonesian financial intelligence unit of that suspicious transaction for further analysis.

If the conduct of BNI, a state-owned bank that is listed on the Jakarta stock exchange, is any guide, then we should really be worried how hopelessly feeble our anti-money laundering efforts have been.

Indonesia could face the bigger risk of being internationally blacklisted again as a haven for dirty money and a high-risk country for financial transactions.

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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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Bangkok's poorly designed capital control rocks stock markets

Friday, December 22, 2006 Vincent Lingga, The Jakarta Post, Jakarta

Thailand's imposition of foreign exchange controls that caused a drop of almost 20 percent in local stock prices and systemic, yet smaller falls in other Asian markets Tuesday, is an example of a well-intentioned, but poorly designed and ill-timed policy.

For Thailand to slam controls on its capital account less than three months after the military coup is certainly counterproductive, especially because the military-appointed government has yet to build up its credibility in the market.

The stock market in Bangkok and other Asian exchanges did rally back Wednesday, recouping most of their losses from the previous day, after the Thai government rescinded the capital controls.

However, the Thai attempt to control capital foreign exchange flows will nevertheless resurrect the debate on the merits and drawbacks of controlling short-term capital inflows.

It was strategic, though, for Indonesian Finance Minister Sri Mulyani Indrawati and Bank Indonesia Governor Burhanuddin Abdullah to immediately and repeatedly reassure the market on Tuesday and Wednesday of Indonesia's strong commitment to upholding its fully open capital account.

Bank Indonesia has issued several regulations to minimize the risks of currency speculation against the rupiah without compromising its open capital account. In 2005, the central bank moved to limit foreign exchange derivative transactions with foreign counterparts against the rupiah to a maximum of US$1 million and to cap dollar purchases in outright forward transactions and swaps at $1 million.

The central bank also imposed a three-month minimum investment hedging period on foreign exchange transactions. This means that investors with underlying investment in Indonesia must keep their funds in the country for at least three months. Hedging transactions subjected to this new regulation include outright forward transactions, swaps and call and put options.

These moves aim to prevent wild volatility of the rupiah by reducing the speculative element in the currency market, by among other things decreasing the inflow of hot money to the country.

The return in droves of foreign portfolio investors to the Asian financial market after the 1997

financial crisis has raised great concern about market vulnerability to boom and bust cycles. Thai authorities have been apprehensive over the steady appreciation of its currency, the baht, and worried about the threat of currency speculation.

The reasons for fully liberalizing capital flows were partly pragmatic, as technological innovations, such as new financial instruments, made it easier to circumvent capital controls.
In Indonesia in particular, controls on foreign exchange flows could be highly problematic and vulnerable to corruption, due to the inadequate institutional capacity and high level of venality within the government bureaucracy.

Most studies have also concluded that liberalizing foreign exchange flows could stimulate growth by reducing distortions and enhancing access to foreign financing, as Thailand and Indonesia have proven with the bullish sentiments in their capital markets.

An open capital account may improve economic performance over the business cycle by encouraging more prudent domestic macroeconomic and financial policies, as well as improving short-term access to financing.

Policymakers in countries such as Indonesia with an open capital account are forced to adopt prudent policies because investors are free to bring their money elsewhere, whereas policymakers in countries with capital controls can pursue less prudent policies without being afraid of facing sudden massive withdrawals of funds, at least in the short run.

The potential long-run benefits of an open capital account must, however, be weighed against immediate costs: a country's vulnerability to global shocks or to sudden changes in investor sentiment. Capital flows are subject to pronounced cycles that may induce boom and bust cycles in production and investment.

One source of vulnerability is a mismatching of maturities or currencies, which makes recipient countries illiquid. Such a severe liquidity shortage makes a system vulnerable to panics, while policymakers' options are severely restricted, as painfully apparent in Indonesia during the height of its financial crisis in early 1998.

With capital controls, a central bank can set both the interest rate and the exchange rate simultaneously, at the cost of limiting capital inflows that could finance productive activity.
The question is do the benefits of liberalizing outweigh the costs?

As Indonesia's experience since the early 1980s have proven, the benefits seem to far exceed the costs.

Chile tried to control short-term (portfolio) capital inflows in 1991 by imposing an unremunerated reserve requirement (URR), first on foreign borrowing (except trade credit) and later on short-term portfolio inflows (foreign currency deposits in commercial banks and potentially speculative foreign direct investment).

The reserve requirement was raised from 20 percent to 30 percent. A minimum stay requirement for direct and portfolio investment from abroad also was imposed.

But these controls seemed to be less-than effective because investors found ways to circumvent the controls. The problems lie mostly in the difficulties in the design and application of capital controls.

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Capitalizing on the Hong Kong platform

Friday, December 08, 2006, The Jakarta Post

The Hong Kong Trade Development Council (HKTDC) invited journalists from Australia, Asia and Europe, including The Jakarta Post's Vincent Lingga, to attend the 7th Hong Kong Forum of business associations from around the world. The meeting discussed the future role of Hong Kong amid the astronomical growth of mainland China's economy, which will probably become the second largest in the world within three to four years. Below are his reports.

Its integration into the global supply chain, its strategic location in the center of Asia and its position as the gateway to the world's fourth largest economy, China, have been and will continue to be the main advantages Hong Kong offers investors.

But the fundamentals that will sustain and even increase Hong Kong's role as the leading trading and financial center in Asia, despite the fantastic growth of China's Shenzhen, Shanghai and Beijing, are what senior economist Helen Chan calls the Hong Kong brand.

Ms Chan, with the Hong Kong Finance Secretary's Office, describes the key components of the Hong Kong brand: a strong rule of law, good governance, first class infrastructure and a credible financial services regulatory system.

Hong Kong Trade Development Council (HKTDC) Chairman Peter Woo uses a slightly different term: the Hong Kong Platform.

The recent issuance of the world's largest initial public offering, US$16 billion worth of shares, on the Hong Kong stock exchange is another indicator of Hong Kong's growing global role.

The Hong Kong equity market is the second largest capital market in Asia and the fourth in the world. With a total market capitalization of over $1.5 trillion, it raised $50 billion in the first 10 months of this year alone.

"As of October, 355 mainland Chinese enterprises were listed in Hong Kong, representing one third of the total number of listed companies and 46 percent of the total market capitalization," Financial Secretary Henry Tang told the Hong Kong Forum. In addition, Tang said, Hong Kong also is a leader in asset management, with $580 billion worth of business last year.

Hong Kong's extensive financial and business service cluster is unique in Asia for its breadth, depth, sophistication and mix of international and local firms. This cluster includes private banking, fund management, corporate finance, currency trading, insurance, venture capital finance, direct corporate investment and stock brokerage as well as support services such as legal, accounting, management consulting, executive search, public relations, advertising, communications and information technology support.

"Hong Kong will remain the leading financial and trading center in Asia," says Bramono Dwiedjanto, general manager of the state-owned Bank Negara Indonesia (BNI), which has operated a full branch in Hong Kong since 1962.

Dwiedjanto told The Jakarta Post last week that a number of financial and trading companies had moved their offices to Singapore immediately after the 1997 financial crisis in East Asia. But most of them have returned to Hong Kong due to its advantages.

" I don't think Singapore will ever take over Hong Kong's position," added Dwiedjanto, who worked for two years at the BNI branch in Singapore.

"Our long international business experience and our knowledge of China make us the best partners for foreign companies to do business with or in China, and for mainland Chinese companies to do business with the outside world," said HKTDC Executive Director Fred Lam.
Lam acknowledged that several cities in China have also been developing as major financial and trade centers.

"But it is not a zero-sum game between Hong Kong, Shenzhen, Shanghai or Beijing. They will supplement each other," Lam said.

Hong Kong is thus poised to play a pivotal role in the modernization of the Chinese economy.
There has been lingering concern about the sustainability of China's economic miracle under its one-party authoritarian system.

But almost 30 years after the opening of China's economy to the outside world, and nearly ten years after Hong Kong's reunification with China, their economic integration is proceeding quickly and smoothly. The "one country, two systems" principle has allowed Hong Kong to retain its capitalist economy and its own legal system.

Clusters of industries

Today many manufacturing companies have moved out of Hong Kong in search of lower-cost land and labor, notably to the Pearl River Delta region in southern China. Still, many industries remain active in Hong Kong, operating their local offices as trading companies and business headquarters that support offshore production.

They mastermind and control the production process from their headquarters in Hong Kong, making the most of location advantages and division of labor.

The relocation of Hong Kong's industry should thus be viewed as an expansion of Hong Kong's industrial sector, according to a 2005 study by Sung Yun Wing and Chou Win Lin of the Chinese University of Hong Kong.

Hong Kong is also a favorite base for the Asian regional headquarters and offices of foreign companies.

" As of October, there were almost 4,000 regional headquarters or offices of foreign companies operating in Hong Kong," said Mark Michelson, an associate director of InvestHK, Hong Kong's investment promotion body.

Superb logistics

Hong Kong manufacturers and exporters have increasingly played the role of integrators, matching demand from North America or Europe with sources of supply throughout Asia and beyond.

Hong Kong can fill this need because it is home to a number of dynamic clusters of interrelated industries that draw on common skill bases and can reinforce each other's competitive positions.
This role was described by Michael J. Enright, Edith E. Scott and Ka-mun Chang in their book,

The Greater Pearl River Delta and the Rise of China. A Hong Kong company might help a garment company in the United States design its autumn collection, for example, and then organize purchasing, manufacturing and logistics to get the product onto retail shelves on time, meeting quality and budget specifications.

Hong Kong's infrastructure and real estate development cluster links property and construction groups with engineers, architects, surveyors and interior designers. Its seaport is among the world's busiest and most efficient container ports.

Hong Kong also offers legal expertise in the area of air and maritime regulations and dispute resolution, as well as finance and insurance for air and sea cargo.

Pearl River Delta

One of the regions that has benefited from Hong Kong's position as a financial and trade center is the Pearl River Delta (PRD), one of the most economically dynamic regions on the Chinese mainland.

PRD has developed into a manufacturing center of global importance and one of the world's fastest growing economic regions, thanks largely to the role of Hong Kong as an international financial and supply chain management center.

PRD, Hong Kong and Macao are now known as the Greater Pearl River Delta economic zone.
While Hong Kong, with a population of only seven million, has developed as a leading center for management, coordination, finance, information and business services, PRD, with a population of more than 60 million, has emerged as a manufacturing powerhouse.

"Greater Pearl River Delta, with a $410 billion gross domestic product last year, accounted for one-fifth of China's $2.2 trillion economy," said economist Chan.

The attractiveness of mainland China, especially its southern region, has shifted investor interest from Southeast Asia to Northeast Asia. Hong Kong has gained a bigger share of these investments, at the expense of Singapore, thanks to its infrastructure, clear and transparent rules and regulations, international access and proximity to large markets.

Since the 1997 Asian financial crisis, major international financial service companies have increasingly concentrated their regional activities in Hong Kong.

The emergence of the PRD region has allowed Hong Kong companies to decentralize many activities from Hong Kong into the surrounding areas. PRD thus accounted for the bulk of Hong Kong-mainland China trade, which totaled $265 billion last year.

Hong Kong has cumulatively invested more than $260 billion in the mainland, mostly in manufacturing plants in the PRD region.

"Some 75 percent of the estimated 80,000 factories established in the PRD region since the late 1970s have been owned by Hong Kong companies," said Michelson.

Future role

In this changing environment, Hong Kong firms may move further up the value chain, upgrading their services and assuming more front- and back-end roles, such as contributing to product design and development.

China's participation in the World Trade Organization and the development of industries in the Pearl River Delta region will provide a greater scope for high-value activities linking these industries through Hong Kong to the rest of the world.

These developments will also provide additional opportunities for foreign investment and the location of management activities for a wider range of multinational companies in Hong Kong. Hence, Hong Kong is positioned to perform high value-added managerial, financial, coordination and information activities across more industries.

"High-technology, research and development activities should be the next dimension of our economy to make Hong Kong not only the trade and financial but also the technology center in Asia," HKTDC Chairman Peter Woo said at the Hong Kong Forum last week.

Hong Kong's economy will likely grow to look more like those of other major cities in developed countries such as Tokyo, New York and London. These global centers thrive on handling flows of knowledge, information, goods and finance, acting as the nodes at which economic activities are managed and financed.

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Agricultural revitalization key to cutting poverty

Monday, December 11, 2006 Vincent Lingga, The Jakarta Post, Jakarta

The findings of the latest World Bank study to the effect that almost 70 percent of the poor in Indonesia live in rural areas and 64 percent work in agriculture boil down to a central message: the fight against poverty should be waged mainly on the rural front.

This does not, however, mean that the focus should be entirely on agriculture as rural non-farm economic activities (micro and small enterprises) also play an increasingly important role as sources of livelihood for villagers.

Although agriculture's contribution to national gross domestic product has declined to less than 20 percent, its direct and indirect contributions to the national economy remain significant through its forward and backward production, distribution and consumption linkages.
Put another way, the agricultural growth multiplier quantifies the impact of an increase in income in the agricultural sector on income growth in other sectors.

However, despite the vital role of agriculture in poverty alleviation, it is quite difficult to see how the Agricultural Revitalization Program of President Susilo Bambang Yudhoyono, launched in July 2005, connects with the new poverty reduction strategy -- the Community Empowerment Program -- that Coordinating Minister for People's Welfare Aburizal Bakrie described at a national poverty conference here last week.

Disappointingly, not a single minister, not even the agriculture minister, has elaborated on the agriculture-revitalization concept after its introduction by Aburizal Bakrie, the then coordinating minister for the economy, almost 18 months ago.

The World Bank report Making the new Indonesia work for the Poor, which was launched last week, reemphasized the vital need for higher productivity in the agriculture sector and rural non-farm small enterprises.

The report endorses the conclusions of similar studies by other domestic and foreign institutions, which have concluded that farmers' incomes can no longer be improved significantly by focusing on such staple crops as rice, cassava, soybean, sugar and corn as such crops will do little to provide additional employment and income growth due to diminishing productivity gains, especially in Java, where most farmers till less than half a hectare.

The problem, though, is that shifting to higher value agricultural activities, such as forestry and horticulture requires high-yield seeds, agriculture extension services, better infrastructure (such as rural roads), up-to-date information flows, market facilities and electricity.
Rural infrastructure is quite vital as in both agriculture and the rural non-farm economy, opportunities for growth can be generated by greater linkages with the urban economy and export markets.

Future agricultural growth will depend largely on urban and international demand for high value agricultural produce. In other words, smooth transportation is vital to facilitating linkages with the farm economy and stimulating the development of rural small enterprises.

The sad reality, however, is that farmers' access to basic services and markets has sharply deteriorated as the result of an acute lack of maintenance of the rural road network since 1998. Likewise, the scope and extent of agriculture extension services has declined since decentralization.

No wonder, agricultural total factor productivity has declined steadily since 1993, according to the World Bank report.

Regional administrations, which under local autonomy play a key role in the provision of both basic services and rural infrastructure, often do not understand the nature and importance of linkages between agriculture and the non-farm economy.

There is nothing wrong with the Community Empowerment Program concept. It will be more effective as it promotes the empowerment and involvement of poor people in conceiving programs, as well as transparent budgeting rules, processes and procedures, good-governance practices and increased accountability.

The program, however, will be less effective in alleviating poverty if it is not supported by strong and competent institutions, and an enabling environment for the revitalization of agriculture and the development of agribusiness in its broadest sense. Yet more challenging is that fact that the responsibility for creating such an enabling climate rests squarely with local government.

The message that one can really draw from the main recommendations of the World Bank study is that poverty alleviation should incorporate the broad objective of empowering farmers (improving their incomes) and the rural community through the development of the farm and non-farm economy, the improvement of rural infrastructure and the provision of basic services.

The revitalization of the agricultural sector will require tight ministerial coordination and cooperation with local administrations in mobilizing resources for the development of such basic infrastructure as roads, markets, processing facilities, rural financial institutions, farm research stations designed to meet area-specific conditions, and technical farm extension services.

The agriculture extension service should be decentralized and be complemented by a conducive business environment to stimulate private investment in the propagation of high-yield seeds for high value crops.

The questions now are twofold: how will the revitalization of the agriculture sector be integrated into the Community Empowerment Program, and which minister will be responsible for coordinating the government functions in all of the multidimensional activities involved in the Community Empowerment Program? Will it be the coordinating minister for people's welfare, Aburizal Bakrie, or the chief economics minister, Boediono?

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Advancing beyond macroeconomic stability

Tuesday, October 17, 2006 Vincent Lingga, The Jakarta Post, Jakarta

This is the second in a series of articles The Jakarta Post will publish to mark President Susilo Bambang Yudhoyono's second anniversary in office on Oct. 20. The first article appeared Monday.

Almost two years into his five-year term and President Susilo Bambang Yudhoyono has yet to fully utilize his strong political mandate to transform the country's macroeconomic stability into improved living standards.

Macroeconomic downside risks have been reduced, fiscal management improved with a sustainable deficit and the government debt-to-GDP ratio halved to below 50 percent.
Macroeconomic stability has strengthened but the economy remains vulnerable to shifts in investor sentiment and occasional asset market volatility, because the bulk of foreign capital inflows consist of short-term, portfolio capital, which can fly out at the slightest sign of policy inconsistency.

The financial sector's performance has improved, though the largest two state-owned banks, Bank Mandiri and Bank BNI, remain fragile due to mountains of bad loans. Gross international reserves have increased markedly to enable the government to amortize all its debts to the International Monetary Fund four years ahead of maturity.

Exports have reached all-time records, expanding by over 17 percent in the first eight months of this year. However, most of this gain should be attributed to luck, as the increase was generated mainly by steep price rises in primary commodities such as palm oil, rubber, coal and oil, not by any improved economic competitiveness on the part of Indonesia.

Different from previous presidents, who were often associated with the abuse of power and rampant corruption, Yudhoyono still presents himself as an honest, hard working person with a great deal of integrity.

But his legitimacy and impeccable integrity will not mean much as people lose patience with his indecisiveness on badly needed reforms to reinvigorate the economy and create jobs.
The President failed to take advantage of his strong mandate and push through significant reforms at the start of his term. And he has failed miserably in the sector most meaningful to the majority of the people -- job creation. Unemployment has instead risen.

Poverty increased by 11.25 percent, or 3.95 million people, to almost 40 million people or 17.75 percent of the total population between February 2005 and March 2006, due to the devastating impact of the doubling of fuel prices in October 2005. This poverty incidence, though lower than that between 1998 and 2002, was the highest since 2003.

We don't mean to say the fuel policy was wrong. It should instead be praised as the boldest measure yet taken by the Yudhoyono government to strengthen the foundations of the economy. Its negative impact should be blamed on a poorly designed social safety net and anti-inflation measures.

Open unemployment and underemployment have reached as high as 40 percent of the 105 million total workforce because of persistently moderate economic growth (below 6 percent) amid an acute lack of new investment. Indonesia has failed to rejoin Asia's club of high-growth countries.

While the pace of economic reform announcements has been much slower than expected, the implementation of policy reforms is even more disappointing. The cascading impact of these problems is a disappointingly slow recovery of public and private investments.

Yet more worrisome is the trend whereby each percentage point of growth now generates fewer jobs in the formal sector than it did before the 1997 economic crisis, because of what most analysts see as the impact of too rigid labor regulations.

Things will not likely improve much in this labor market because the government has succumbed to demands of trade unions who oppose the amendments to the 2003 Labor Law, even though they represent no more than 5 percent of the total workforce.

The government apparently does not realize that in the long term, companies, workers and society as a whole will benefit from a more flexible labor market where workers have an incentive to invest in their own social capital and lifelong learning in the competition for better jobs.

Worse still, another set of important economic laws regarding taxation and investment, already several years behind schedule, will most likely suffer another delay. The only small consolation is the new customs law, which is scheduled to be approved by the House of Representatives tomorrow (Oct. 18).

The Infrastructure Summit held last November to woo new investment fell flat due to uncertainty about legal frameworks and lack of clear-cut provisions on government-private sector partnership and risk management. The second Infrastructure Summit, scheduled for next month, does not seem very promising either because of the delay in the formulation of a more conducive regulatory environment.

Promises and symbolic moves, though needed, are not enough to maintain the momentum of market confidence. The market requires concrete measures because only consistent and effective implementation will give credibility to government policies.

As long as the President remains hesitant to assert stronger political leadership to push through key reform measures and vital infrastructure projects, the pace of new investment will remain slow and the economy will continue to muddle through, unable to generate enough jobs for the unemployed and new entrants to the labor market, and lift the 40 million up from poverty.

However we define it, the high rates of unemployment and absolute poverty mean that our economy is languishing in critical condition. And a crisis requires strong political leadership and a fast, credible decision-making system.

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Global economic imbalances raise risks of hard landing

Tuesday, September 26, 2006 Vincent Lingga, The Jakarta Post

The 2006 Global Meeting of the Emerging Markets Forum (EMF) here last week warned that the risks of a hard landing for the global economy had increased with the United States continuing its profligate spending amid steadily rising oil prices.

The EMF, an independent not-for-profit initiative of the Washington-based strategic advisory company, Centennial Group, sounded more pessimistic than the International Monetary Fund, which still foresaw a higher probability of a gradual, orderly adjustment of the American dollar.

Panelists and discussants at the EMF meeting, including several former senior executives of the International Monetary Fund and the World Bank, were worried that the U.S. current account imbalance is likely to worsen further. They said the adjustment process was being made even more difficult as a result of the combined impact of the steep hikes in oil prices and the decline in the propensity of net oil exporters to import from the U.S and to invest in dollar assets.

While oil exporters, notably in the Middle East, are together accumulating US$1 billion in a net current account surplus every day, it is estimated that the U.S. will book a $900 billion deficit this year, as against $800 billion last year.

The U.S. has often been warned that its excessive consumption is dangerous for both itself and the world economy, but so far Americans have ignored such doom-mongering, increasing the risks of a hard landing for the global financial market.

As long as American and foreign central banks, notably those in Asia, are locked in a codependent relationship, the U.S. will likely continue its spending spree. According to the latest estimates by the IMF, more than half of all publicly available U.S. Treasury bonds are now held abroad, notably by central banks in Asia. These banks are thus trapped in something of a vicious circle.

Even though the IMF also recognizes some downside risks, it asserts in its 2006 Global Financial Stability Report, which was issued in Singapore last week, that "the structural strength of the U.S. financial market has no doubt enhanced the scale and sustainability of the U.S. current account deficit. The continuing confidence of international investors in U.S. markets supports the prospects of orderly adjustment in current imbalances."

The World Bank estimates that roughly 70 percent of global foreign reserves are now in dollars, making them highly vulnerable to currency correction. An abrupt change in the dollar value could spell trouble, as central banks find themselves with black holes in their portfolios.

Obviously this is neither healthy nor sustainable in the long run. But will the political will emerge to correct the imbalances?

This is unlikely in the near future. It seems that it will be extremely difficult to reach a global consensus to address these global imbalances. There seems to be a mood of complacency given that the markets have thus far been prepared to absorb the imbalances.

The natural adjustment mechanism for America's rapidly growing foreign liabilities should theoretically be a declining dollar, which would lower demand for imports and make America's exports more attractive on foreign markets. But the Asian central banks have been stalling this process as they want to keep their currencies from appreciating against the dollar, and are thus buying sackloads of dollars.

The pressures on the U.S. to get is fiscal house in order by cutting its budget deficit and encouraging American consumers to save are not enough. Too steep a fall in American consumption could instead threaten the world economy with a deep recession. This is because it is the spending binge in the U.S. that has absorbed a steady stream of exports and capital inflows from Asia and other emerging markets.

Hence, reform policies should be implemented to foster the necessary adjustments in saving and investment imbalances, especially in countries that are the main counterparts to the global current account imbalances, notably the U.S., China, Japan, Germany.

There is another factor that has increased the risks of a hard landing for the global economy and made it more urgent and imperative to intensify multilateral consultations so as to achieve a global consensus on ways to correct the global imbalances.

Besides the declining propensity of sovereign Arab oil exporters to invest in U.S. assets and the diversification of their portfolio investments away from dollar assets, the increasing accumulation of petro-dollars by private oil exporters is posing another threat to global financial stability.

This development is shifting the institutional management of an increasing amount of money around the world from central banks in Asia, which hold huge foreign reserves in dollars, to private oil exporters. While central banks are more conservative and constrained in their investment choices (they usually prefer U.S. Treasuries), private oil exporters are entirely free to invest wherever they choose.

The change in the investment behavior of oil exporters, which have been accumulating huge surpluses, could change the pattern of global capital flows at the expense of an orderly adjustment of the global imbalances.

The IMF seems to be the most technically competent body to keep monitoring and analyzing the investment behavior of sovereign and private oil exporters, and to ring the alarm bell whenever necessary. But this institution needs to be given the instruments it requires to strengthen its multilateral surveillance.

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WB needs to wean itself off 'nanny' bank role

Thursday, September 21, 2006 Vincent Lingga, The Jakarta Post, Jakarta

The World Bank is an easy target for attacks from all sides given the conflicting demands of its 184 member countries. The bank is mostly active in developing countries, which make up the majority of its members, but its decision and policy-making is controlled by the few developed countries who make up the majority of shareholders.

The perception that the bank merely purveys the policies of developed countries, especially the United States, is therefore unavoidable. This notion is reinforced by the fact that it, together with the International Monetary Fund, is headquartered in Washington and that the U.S. has the privilege of appointing the bank's president.

The bank is under tremendous pressure. Most civil society organizations assail it for what they see as its failure to reduce poverty in the poor countries.

Developed countries criticize the bank for not using its leverage as a lender forcefully enough to obtain meaningful reform in the developing world.

The internal reforms the bank started making in the early 1990s by decentralizing, relocating its decision-making process to the country level, were apparently not fast enough to satisfy developing countries.
Indonesian Finance Minister Sri Mulyani Indrawati expressed the view of most other developing countries when she criticized the World Bank for often acting as a preacher, rather than a partner for developing countries.

Indeed, with annual lending resources of US$20 billion and the largest pool of development thinkers any single organization in the world has ever possessed, the bank's executives, many of whom are from developed countries, often face a strong temptation to act as arrogant advisers.

The bank, with over 10,000 well-paid professionals, commands a brain trust with a huge pool of broad-ranging knowledge and experience on the full range of technical and economic issues of development. Its experts possess the wealth of real-life development experience that the bank's lending operations have generated.

The bank started decentralizing its decision-making by appointing country directors who had the kind of power over budgets and projects that used to exist only at headquarters. But the results were seemingly far below expectations.

It was this slow-paced decentralization Sri Mulyani appeared to refer to when she noted at the World Bank-International Monetary Fund Meetings in Singapore on Tuesday that the World Bank should change the way it works on the front line.

The bank needs to strengthen its decentralization policy because it needs country-specific knowledge and expertise to help develop local institutions tailored to local political and social realities.

The country director in each member country therefore must have political savvy and be sensitive to a country's political constraints and to the opportunities of responsible leaders to push reform. That implies a premium on systematic analysis of local politics and institutions.

Under the rubric of country ownership, the bank has tried to tailor its lending policies so that clients have more say in their design.

The emphasis on local politics and institutions is crucial because institutional capacity, the quality of governance and the commitment to development differ widely from one country to another in the developing world. The bank's approach should take these differences into account.

The emphasis on local institutions and local ownership of policies, which was reasserted by the World Bank-IMF Development Committee (the highest policy-making body) in Singapore, was aimed at building respect for and partnership with local efforts by the bank staff.

As a Washington-based independent think tank, the Center for Global Development, suggested in a recent report, "the Bank should become less of a nanny bank, preoccupied with detailed conditionality and structural reforms. It should instead concentrate more on supporting healthy local economic and political institutions."

However, local political ownership is not necessarily conducive to equitable growth, as can clearly be seen in Indonesia under the authoritarian Soeharto administration. The World Bank, instead of forcing reform on Indonesia, fully supported the economic policies of the Soeharto government for more than 30 years and condoned its corrupt system.

The bank's effectiveness then depends on how it manages its lending operations in order to support policy reforms and development result.

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IMF reforming its decision-making mechanism

Wednesday, September 20, 2006 Vincent Lingga, The Jakarta Post, Jakarta

The International Monetary Fund took a major step Monday toward improving its acceptance and credibility among developing countries by adopting a package of reforms on quotas and voice in the IMF, with respect to its decision- and policy-making powers and the reshaping of its surveillance foundations.

These reforms are the first step in a long process that will increase the representation of many developing countries to reflect their rise in the global economy. Right away, the resolution of the IMF board of governors will increase the voting power of four countries -- China, Korea, Mexico, and Turkey -- that are most clearly underrepresented.

Equally important is that the board of governors has agreed the IMF must strengthen the voice and representation of poor countries that continue to borrow from the IMF but only have a limited share in IMF voting.

The reforms will improve legitimacy, in terms of how IMF governance is structured and how that is perceived among developing countries, which have long complained about what they see as the grossly unfair control of the IMF by developed countries.

Experience has shown it is not enough for the IMF, and its Bretton Woods sister -- the World Bank -- for that matter to prescribe the right policy advice. This advice is more likely to be accepted if it comes from an institution that is seen as representative of the interests of developing countries, which make up the majority of members and borrowers from the IMF.

The reforms just adopted by the highest policy -making body of the IMF will go along way toward improving IMF acceptance and credibility. The IMF's credibility will continue to be undermined if the monopolistic behavior of large countries with veto power is not checked.

Still encouraging is that more reforms are in the pipeline as the board of governors also has ordered the IMF executive board to reach an agreement on a new quota formula to guide the assessment of the adequacy of members' quotas in the IMF. Such a formula should provide a simpler and more transparent means of capturing members' relative positions in the world economy.

The present IMF quotas have been seen by most members as a distorted mirror of today's economy because they must do three things at once: They determine how many votes a member can cast on the board, how much money a country must put into the IMF coffers, and how many dollars a country can take out before attracting penalty interest rates. As a result, many countries are now underrepresented.

The reforms are implemented at a time when the IMF's popularity is at its nadir and its budget is shrinking because many of its best customers are now doing without it.

What then are the jobs of the IMF? Apart from generating mountains of analyses, the IMF's function is to inject foreign exchange in countries that have temporarily run short. But lately no one has been calling on its reserves. Brazil and Argentina have both repaid their debts. Even Indonesia has paid in advance half its $7.8 billion debts and plans to amortize the remainder later this year. Hence, now only Turkey still owes a significant amount of money to the IMF.

With no way of treating members in financial crisis with what "patients see as bitter pills", the IMF is left only with the power of surveillance, keeping an eye on the policies and frailties of its members. But even this surveillance role has increasingly been detested in many countries, especially in Asia.

But the fact is that, like it or not, the IMF's role as an emergency lender is still relevant, at least until regional financial cooperation can be expanded through reserve pooling. After all the IMF can immediately call on about $220 billion of hard currency if needed to help countries in financial distress.

True, South Korea, Japan, Singapore, Indonesia, China, Malaysia, the Philippines and Thailand, which together command international reserves worth 10 times the IMF total, have begun pooling a small fraction of their resources under an initiative launched in Chiang Mai in 2000. But this regional arrangement has yet to be tested.

If emerging economies want to insure themselves against financial crisis it would not be cost efficient to set up their own "safety net" to make emergency lending available. But how can the IMF, as an emergency lender to all countries, regain the confidence of its estranged members.

That is the main objective of the package of reforms adopted by the IMF board of governors at its annual meetings in Singapore.

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Regulations the biggest barrier to new investment

Monday, September 11, 2006 Vincent Lingga, The Jakarta Post,

Indonesia may find some consolation in the praise of the World Bank and its private-sector arm, the International Finance Corporation, over the improvements made in its business climate but this commendation means virtually nothing in the way of wooing investments because most other countries performed much better.

Indonesia predictably remains among the most difficult places in terms of the ease of doing business, ranked 135th of 175 countries surveyed for the 2007 Doing Business report, compared to 131st among 155 countries in the 2006 report, which tracks indicators of the time and cost of meeting government requirements in business startup, operation, trade, taxation and closure.

The fourth annual Doing Business survey measures quantitative indicators on business regulations and compares their enforcement across 175 economies based on data available as of last January.

The report, therefore, does not cover developments after the launch of the investment policy reform last March, which calls for expediting the time of business startup to 30 days.

But do not expect too much from the government's regulatory reform. Indonesia has been notorious as a laggard in reforms. Even President Susilo Bambang Yudhoyono, who came to office with a strong political mandate, failed to get the message from the Doing Business survey "take advantage of your new mandate and push through significant reforms at the start of your term.

The government did succeed in cutting down the time and cost of starting up business from 151 to 97 days and from the equivalent of $1,300, or 101.70 percent of the country's gross per capita income, to $1,111 last year, but scored poorly on most other key indicators.

The country would have scored much lower still if the ranking included such variables as macroeconomic stability, the quality of infrastructure, currency volatility, investor perception and law and order.

The comparative data in the report should give the government, notably chief economics minister Boediono, the ability to measure the government's regulatory performance compared to that of other countries, taking good lessons from global best practices to prioritize reforms.

It is disappointing to note that even among the ASEAN countries, Indonesia only scored better than Laos.

It took about 224 days in Indonesia to comply with all licensing and permit requirements, compared to the average of 147.4 days in the Asian region. The enforcement of commercial contracts took about 126.5 days, as against the Asian average of 52.7 days. Employment regulations were also among the most rigid.

Once incorporated, a company may want to buy land upon which to build a plant but the cost of registering property in Indonesia has reached as high as 10.5 percent of the property value, compared to the average of four percent in the region.

Overall, businesses in Indonesia often shoulder administrative costs that are twice as high and have to struggle through twice as many bureaucratic procedures as their counterparts in other Asian countries.

The March investment policy reform was designed to address all these business woes by expediting the procedures for business startup, speeding up customs, licensing, and court procedures, and made labor regulation more flexible.

As businesspeople here can easily testify, pointless regulations foster graft as the more irksome the rules, the greater the incentive to bribe officials not to enforce them. Because it is so difficult to obey all the rules, businesses tend to remain informal -- outside the law and the tax net. They cannot raise credit from the formal banking system.

However, it is not reasonable to expect a much faster pace of regulatory reform in the country. At best, improvements will be incremental, as found by the latest World Bank report.

The central government may be able to push harder with reforming and streamlining the first two sets of procedures for starting up business: First, by obtaining approval from the Investment Coordinating Board and second, through establishing a limited liability corporation through the Justice and Human Rights Ministry, which requires at least 10 different procedures involving notaries, banks and the tax department.

But the third set of procedures -- obtaining numerous licenses and registrations from ministries and local governments -- could be the hardest part because local administrations often follow their own rules, setting their own standards and criteria.

The government, therefore, took a shortcut by introducing last June the concept of a special-economic zone, which is being implemented on Batam, Bintan and Karimun islands in cooperation with the Singaporean government.

The regulatory environment and physical infrastructure in these SEZs will be developed to the standard of at least the world's 30 top performers in terms of the ease of doing business.

The government seems determined to turn the three SEZs into islands of competence, growth poles and catalysts for investment promotion in other parts of the country.

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