Deregulation makes RI attractive but interest rates to rise

Deregulation makes RI attractive but interest rates to rise

JAKARTA (JP): Merrill Lynch & Co. of the United States says
recent deregulatory measures make Indonesia the region's best
site for foreign investment but warns that interest rates will
likely edge higher next year.

The global securities research and economics company said in
its latest monthly review, Asian Economic Commentary, that
Indonesia's recent bold moves toward economic deregulation and a
series of policy changes are likely to put it at the very
forefront in terms of competition for the global investment
dollar.

"Heeding earlier criticism from several quarters that
Indonesia was rapidly losing out to countries like China, India
and Vietnam in competition for foreign investment, the Indonesian
government moved to thoroughly revamp its investment laws," the
report said.

Last month, the Indonesian government introduced a new policy
package, including import duty cuts for the agricultural, health
and industrial sectors in anticipation of world trade
developments. The package was meant to increase the
competitiveness of Indonesian products in the international
market.

Less than a month earlier the government had eased
restrictions on foreign investments, allowing foreign investors
to hold up to 100 percent in equity of projects in virtually all
sectors of the economy.

According to the review, one of the most significant measures
in the latest package is the abolition of minimum capital
requirements for foreign investors. "These new rules should
facilitate the development of small-scale and medium-sized
industries that are likely to be critical to Indonesia's overall
industrialization efforts.

The report also praised the Indonesian government's decision
to substantially ease divestment rules.

"While foreign investors had been allowed previously to retain
100 percent ownership for at most 10 years, this has now been
extended to 15 years," it said.

"More importantly, the divestment will be largely symbolic now
and can be as small as one percent, as compared to the past
requirement that, at least, 51 percent of equity be sold to local
partners," Merril Lynch & Co. said.

Another important measure is the lowering of minimum local
equity requirement for joint ventures from 20 percent to five
percent.

Together with other significant deregulatory moves in ports,
power generation, telecommunications, shipping, civil aviation,
transportation, railways, water supply, education and mass media,
Indonesia is expected become one of the most attractive
destinations in Asia for foreign capital.

"In terms of its more immediate competitors, Indonesia's new
investment rules would put it significantly ahead of China, India
and Vietnam," the report added.

High costs

Merrill Lynch, however, cautioned that in spite of its
significant moves, Indonesia still needs to further reduce the
high cost structure of its economy.

"Although wages in Indonesia are lower than other Asian
countries, like Malaysia and Thailand, the difference may be
narrower if productivity is taken into account," the company
said.

In addition, the hidden costs of doing business in Indonesia
are still relatively high due to the complex, time-consuming
procedures and a significant amount of red tape. The report also
cited that protection of upstream industries, either via
monopolies or import restrictions, implies inefficiency and
higher costs for downstream industries.

The cost of capital is another key factor that makes for the
current high-cost structure of the economy. "Although past
financial reforms have brought down the cost of funds
substantially, average lending rates for working capital at 17.3
percent at the end of March were significantly higher than
comparable rates elsewhere in the region," it said.

"Although local interest rates stand sharply lower today
compared with the highs of 1991 (the lending rate at end-April
1991 was 27.1 percent), spreads between deposit rates and lending
rates are still large," it said.

The review conceded that more competition in the banking
sector has helped narrow the spreads, although one constraint in
the near term could be the problem of bad debts, especially among
state-owned banks.

It cautioned that Indonesia will take several years to resolve
the problem of non-performing loans, which are estimated to
account for 16 percent of total outstanding credit.

The review praised the Indonesian government's efforts at
curbing the banking sector's bad loans and bringing to justice
those responsible for the loans.

Domestic demand

Merrill Lynch also predicts that net external demand will
remain a major force of Indonesia's economic growth.

"Domestic demand is expected to be the major impetus to its
gross domestic product (GDP) growth in 1994," the report said,
adding that private consumer growth should rise further to a
range of between seven percent and 7.5 percent in 1994, following
growth of 6.2 percent last year.

It said that growth of real incomes will stem from rapid wage
increases and a drop in inflation from the almost double-digit
rate of 1993. Early this year, minimum wages were revised up
sharply, in some cases by as much as 50 percent.

The review also noted that the need to upgrade infrastructure
and expand productive capacity, coupled with the new foreign
investment policies, should also see fixed investment growth.

Fixed capital formation is forecast to grow by nine percent to
9.5 percent in 1994, compared to the 4.9 percent growth last
year. (fhp)