Political stability remains key to foreign investment

Political stability remains key to foreign investment

JAKARTA (JP): The government's recent move to allow foreign
investors to control a majority stake in local banks will not
lure foreign companies if political uncertainty in the country
remains high, a senior foreign banker said yesterday.

Executive vice president of the U.S. Exim Bank, Allan I.
Mendelowitz, said political stability was the main factor foreign
investors looked at in Indonesia.

Before investing in an Indonesian bank, investors would be
sure to investigate whether the bank's operations were based on
international standards, he said.

"World class financial institutions will only be tempted to
invest here if political uncertainty and confidence has been
restored," he told reporters on the sidelines of a seminar held
by the Jakarta chapter of the Indonesian Economists Association
(ISEI).

The government announced Monday that it planned to allow
foreign investors to hold controlling ownership of Indonesian
banks either through direct placement or portfolio investment as
part of its effort to improve the country's ailing banking
sector.

Mendelowitz said the move, combined with the government's
suspension of three banks and the nationalization of four others
last Friday, was not strong enough to restore market confidence
since the key factor in the country's financial catastrophe was
the banking industry's poor lending strategies.

"Foreign financial institutions will only bring their huge
capital and professional financial management systems here if
lending practices are based on international standards," he said.

The fact that many lenders had made important credit decisions
based on "golf course" due diligence, or personal connections,
had significantly intensified the region's economic crisis, he
said.

"The main problem with much of the lending in East Asia,
including Indonesia, is that it was not based on an arms-length
credit analysis," he said, pointing out that its impact was
further exaggerated because banks accounted for a much larger
proportion of financial market intermediation here than is
typical today in other countries.

He said lending policies in East Asian countries were largely
based on "efforts by insiders to enrich themselves and their
friends or political protectors".

The result of such corrupt lending practices was the
inefficient deployment of capital into unproductive investments,
such as unprofitable industries and real estate speculation, he
said.

"Another result was the misallocation of capital, leading to
bad loans," he said.

If the misallocation of capital was systematic, he continued,
it would weigh down the entire banking system with bad debt and a
system-wide banking crisis.

Cleaning up ailing banks' balance sheets is "only the easier
part of the solution" to getting the financial sector of an
economy back on track.

He said bad debt could be taken off the books of bad banks and
that the banks could be recapitalized.

A greater challenge, though, would involve changing the credit
culture and lending practices of East Asia's banking industry.

A second and equally important challenge, Mendelowitz said,
was to build an effective regulatory system for financial markets
so that governments could play the role of referee by keeping
everyone playing by the rules of the game.

He stressed, however, that failure to make these kinds of
changes would place any kind of recapitalization of the banking
system at risk of sending good money after bad.

"If the structural problems are not resolved, there is no
reason to expect that a future crisis will not put the banking
sector at risk again, along with the industrial and commercial
life of the country," he said. (aly)