Corporate reform and the forgotten agenda

Sahala Sianipar, Regional business analyst, Singapore

The current economic slowdown experienced by most countries in Southeast Asia reinforces the need for key structural reform measures. While the economies in Southeast Asia vary in terms of gross domestic product per capita, capital market capitalization and monetary indicators (e.g. foreign reserves, interest rate policy), they also share common problems such as the lack of competitive environment for businesses and poor implementation of governance in capital markets.

These structural barriers to the growth of efficient and competitive market environment were not immediately removed following the 1997 financial crisis.

The delay in the structural reform in these key markets was largely due to the economic growth momentum in the United States. However beginning in 2000, the United States' economy has slowed down considerably, largely due to excesses in the high-tech industry.

The rapid slowdown did not provide enough space for the economies in Southeast Asia to fully recover from the 1997 financial crisis. More importantly, these economies have not fully implemented structural reform to address the excesses in the banking and financial services industries that led to the crisis in the first place.

Following the financial crisis in 1997, policymakers in Southeast Asia have been occupied with massive public bailouts at the expense of painful short-term reform measures. The types of bailout schemes range from the issuance of government bonds to clean bank balance sheets in Indonesia, equity purchase of large business groups using employee funds in Malaysia and transfer of nonperforming assets to a national asset management group in Thailand.

Yet a key component to the creation of transparent and competitive economy is sound corporate governance and its application in Indonesia. A key factor to a sustained economic development is the existence of governance mechanisms that will guarantee transparency, accountability and fairness in the economy, in particular the private sector.

Policymakers can no longer afford to treat corporate governance as merely part of their rhetoric to attract new investment.

The consolidation in the U.S. and European markets will have significant impacts on the flow of new investment to emerging and newly developed markets in Asia including Indonesia. Foreign investors require a stricter condition before they commit new investment; and the existence of strong corporate governance rules and mechanisms is one of the prerequisites.

During 2000, there were many consolidations and much restructuring in the United States as a result of excesses from more than eight years of economic expansion. The consolidation affected initially high-tech firms, and later the financial services and manufacturing sectors.

The restructuring in high-tech industry affected subcontracting firms in countries such as Malaysia, Singapore, Taiwan and South Korea. These markets have relied heavily on the U.S. market. In 1999, more than 57 percent of foreign direct investment in the manufacturing sector in Singapore came from the United States.

Singapore's economy suffered from contraction in the second quarter of 2001 as a result of the weak demand for electronic and high-tech products in the United States. The Stock Exchange of Singapore (SES) has suffered a decline of 24.9 percent in market capitalization since many of its listed companies are involved in the electronic and high-tech sectors that are vulnerable to the downturn in the U.S. economy.

Besides external factors, markets in Southeast Asia have to deal with internal problems, including on the issue of weak corporate governance.

Many investors have been cautious on the Singapore market as a result of the bankruptcy of a major Singapore-based pulp and paper producer, Asia Pulp and Paper (APP) and the irregular transactions involving Golden Agri Resources (a Singapore-listed firm) that placed S$170 million in a bank based in the Cook Islands. Foreign investors prefer Hong Kong's capital market due to its higher level of transparency and efficiency.

This can be discouraging for any attempts to attract investors to Southeast Asia, particularly Indonesia that expects significant budgetary contribution from the privatization and asset disposal programs.

There will not be any short cuts to corporate governance. In the case of Indonesia, there are several possible measures to promote increased level of corporate governance.

First, the government needs to accelerate the establishment of an independent capital market supervisory agency with the authority to impose strict sanctions on any types of violations in the capital market.

The word "independent" can be confusing, especially in the context of Indonesia's public policymaking process. Should the agency be responsible to either the executive or legislative branches or should it be "immune" from executive intervention? The case with the independent commission on fair competition as stipulated under the Competition Law can serve as an example.

Second, the government should revise Capital Market Law No. 9/1995 to ensure that it is on a par with international standards. For example, the law should include provisions to require listed companies to publish information on cross-holding transactions, including with their overseas subsidiaries.

Listed companies should also have independent directors on the board of directors. Moreover, listed companies should be encouraged to offer all of their shares in the market to avoid concentration of shares ownership by certain parties or individuals.

Third, the privatization program of state-owned enterprises should place priority on listing shares in the capital market. In doing so, the program would promote the creation of a level playing field to any interested investors.

Fourth, the government should allow bankruptcies to take place without any intervention. Bankruptcy is part of the business cycle and often companies that can restructure their operation under bankruptcy protection will emerge stronger.

There are many other policy measures that should be considered, including creating a level playing field in the banking sector -- such as minimizing or eliminating special loan programs or lending procedures that cause moral hazards -- and reform in the judicial area.

Indonesia does not have too many options other than to show its commitment to creating a transparent and competitive economy that will attract new investment.