Financial reform's effect on SMEs

By Sahala Sianipar

JAKARTA (JP): The recent Asia Pacific Economic Cooperation (APEC) Ministerial meeting in Christchurch, New Zealand issued a joint statement on the need to empower member countries' small and medium enterprises (SMEs) to take more proactive roles in the context of the region's economic recovery process. Governments in the Asia-Pacific region have begun considering ways to increase the level of SMEs' participation in the economic recover process.

Governments argue that SMEs have higher degrees of resilience compared to large business, thus policy options during the crisis should include measures that place greater priority on SMEs. The debate on the role of SMEs has intensified in the context of the impact of Indonesia's economic crisis. Many parties point out the need for greater government involvement to empower SMEs, so they can emerge as "main economic pillars" postcrisis.

The Indonesian government's plan to reposition Bank Rakyat Indonesia (BRI) to serve SMEs, and the establishment of PT Permodalan Nasional Madani (PNM) illustrate some of the government's measures to develop stronger SMEs. On the other hand, experts and many SMEs argue that a lower degree of government intervention will contribute more positively to the development of competitive SMEs, such as the creation of a conducive business environment with lower transaction costs.

Despite the continuous debate on the role of the government relating to SME development, there is one critical area that deserves greater attention by SME policy planners, that is, the impact of Indonesia's financial reform on the development of SMEs. To what extent have policy planners considered the implications of the banking restructuring program on SMEs? To what extent have policy planners searched for "alternative" financing mechanisms for SMEs that will not jeopardize the macroeconomic stability for many years to come?

Indeed, most of the government's current measures on SMEs have focused on the financing issue (for example, the introduction of 17 subsidized credit schemes for cooperatives and small business). However, they have not answered the fundamental issue at hand, which is SMEs' access to financing mechanisms.

Before the economic crisis, SMEs faced obstacles to obtain equal and fair access to capital. The central bank's requirement to allocate 20 percent of all commercial banks' loan portfolio to SMEs was not implemented effectively due to the high cost of funds to channel SME loans. SMEs relied heavily on self-financing or other "independent" capital generation mechanisms (for example, supplier credit or friends and family).

Consequently, SMEs' exposure to the current banking crisis has been minimum. By the end of 1996, Indonesia's foreign loan (public and private) constituted 73 percent of the country's GDP, compared to the Philippines, 64 percent, Thailand, 63 percent, Malaysia, 56 percent, Singapore, 15 percent, and Taiwan, 12 percent (Far Eastern Economic Review, March 1999). Large enterprises in Indonesia and other Asian countries contributed to the high level of foreign loan exposure in the region. These countries, including Indonesia, must undertake a massive banking restructuring program that will cause major downsizing in the industry.

The current banking restructuring program in Indonesia should aim to create a transparent, efficient and fair banking industry for all economic actors, including SMEs. Should the banking restructuring effort lead to the creation of a special bank servicing only SMEs? What will it take to enhance SME access to the banking sector?

An important outcome to the banking restructuring program should be a higher degree of transparency, efficiency and fairness in the banking sector. Having said that, the creation of a special bank to service SME clients only may not bring the desired long-term result. Banking executives know that SME loans are more expensive than other commercial-lending programs.

Commercial banks should not be forced to channel funds to SMEs (as in the past) because banks do not necessarily have the capacity to do so. Commercial banks should decide, based on their own research and recommendations, to extend loans to their SME clients. A transparent and fair banking industry is a prerequisite to improve SME access to banking services. Commercial banks will realize the profitability of servicing SME clients only if they have the capacity to administer such programs.

An alternative to SME financing is the capital market industry. The capital market (i.e. The Jakarta Stock Exchange as the main equity market) should aim to position itself as an alternative capital generating vehicle to all economic actors including SMEs. The restructuring of the capital market industry should contribute to enhance the level of transparency, fairness and liquidity in the market.

While capital market authorities have joined the intensive debate on ways to service SMEs, such as through the establishment of two-board trading system, it is still premature to state that the capital market can fulfill its intended mission as an alternative financing institution. There are a series of fundamental issues at hand, namely listing costs, structure of ownership, market liquidity and efficiency and financial disclosure requirements, that need to be considered as part of the capital market restructuring effort. Can we attribute the recent gain of share prices in Jakarta to the fundamental recovery of listed companies? While there are fundamental reasons for those listed firms' shares with export potential, such as in agribusiness, to increase, there have not been any significant change to many listed companies' fundamentals that can explain the recent gain in the stock exchange.

The majority of listed companies are still saddled with a high level of foreign debts that have not been restructured successfully. Information on these companies foreign exposure (e.g. currency and derivative losses) has not been fully disclosed, which has prohibited successful debt restructuring.

The absence of accurate information also suggests that the market efficiency level in the country's equity market remains low. The low level of market efficiency increases risk level in the market that ultimately imposes additional costs to potential listed firms and investors. Indonesia's capital market authorities should gradually transform the market to be more efficient and transparent through concrete measures, such as the improvement of financial disclosure and listing requirements to match other international capital markets.

The capital market needs also to diversify its listed companies portfolio, which is currently dominated by manufacturing, property-related and financial services firms.

While the capital market industry goes through major restructuring, policymakers should also consider ways to enhance the growth of venture capital industry. Venture capital plays an intermediary role for SMEs wishing to tap into the capital market but need management and financial assistance in their early stages of development.

Taiwan's venture capital industry has grown to be the largest in Asia, with clients ranging from computer chip manufacturers to biotechnology firms all over the world. A key element to a thriving venture capital industry is a business environment with lower transaction costs that will encourage a greater level of entrepreneurship and risk-taking behavior. Indonesia has many potential entrepreneurs, but the high level of transaction costs (due to burdensome licensing procedures, excessive levies, limited access to capital, poor competition environment and a discriminatory tax regime) has hindered their growth potential.

The current financial restructuring program in Indonesia should address such policy constraints if the ultimate objective is to promote efficient and transparent financial industry including venture capital, for the benefit of economic actors, particularly SMEs. The growth of venture capital will have significant contribution to the development of the Indonesian capital market industry and SMEs.

In closing, successful financial reform will need concrete long-term objectives, and if one of the objectives is to enhance the growth of competitive SMEs, then the creation of a conducive, transparent and efficient business environment is urgently needed.

The writer manages small medium enterprise and economics programs for a nonprofit organization in Jakarta. Opinions expressed are his own.