The capital market versus the banking system
The capital market versus the banking system
By I. Putu Gede Ary Suta
This is the second of two articles on the capital market and
the government's privatization policy.
JAKARTA (JP): Some progress has been made in the development
of the capital market despite weak government support. Between
1990 and 1997, the Capital Market Supervisory Agency (Bapepam)
drafted sophisticated securities regulations that met
international standards. Bapepam became one of the most open and
transparent of government agencies. However, tax and banking
policies were beyond Bapepam's authority and created a barrier to
market development.
In addition to establishing an honest banking system, we
should give priority to a dynamic capital market that will
support stable economic growth. A number of measures must be
taken:
* End Bad Banking: When companies can borrow from banks they
control and when state banks supply funds to friends of
government officials, it is easier to raise long-term funds by
borrowing depositors' money from "friendly banks" than by a
public offering of shares. State banks set a bad example and
discourage sound banking practices, constituting a barrier to
capital market development.
The United States has rigorous banking prohibitions against
conflict-of-interest transactions, joint-ownership and
"interlocking directorates". Except for a central bank and
development banks, there is no justification for state banks.
Government banks, including the banks in the restructuring
program, should be privatized with control transferred to parties
unaffiliated with borrowers.
* Encourage Equity Investment: Because, unlike bank deposits,
the government does not guarantee equity investments and because
return on equity is uncertain and dependent upon market forces,
investors prefer government guaranteed bank deposits, especially
when interest rates are high. Countries intent on developing
capital markets provide incentives for the public to use equities
for long-term savings. This calls for major policy changes:
* Limit Deposit Guarantees and Bank Interest Rates: Government
guarantees on bank deposits must be limited and subject to
interest rate restrictions. Otherwise, the government guarantee
creates a "moral hazard" in which weak banks attract money by
offering high interest rates, while discouraging investment in
stocks and long-term bonds.
* Postpone Taxes for Retirement and Educational Funds: To
compensate the risk and long-term nature of equity investments,
many governments allow investors to save for retirement or their
children's education in funds exempt from current taxation. Taxes
are due only when profits are withdrawn. The country benefits
from greater economic stability through equity financing.
* Encourage Public Companies: Strong incentives are needed to
compensate for the cost of distributing equity in an undeveloped
market. Some countries stimulate capital market development by
lower taxation of public corporations. For example, a company
with capital distributed to 5,000 domestic shareholders might be
allowed a reduction on corporate taxes, compensated by higher
taxes on nonpublic companies. To qualify for tax benefits, the
public company must meet disclosure and corporate governance
standards.
* Make Bapepam Independent: Bapepam has not been able to
effectively exercise its enforcement powers because it is not
free from political influence. Recent recommendations call for
the transformation of Bapepam into an independent agency under
the supervision of a board of commissioners, with similar
safeguards as the United States' Security and Exchanges.
* Accelerate Privatization: The purpose of privatization is
not to raise funds for the government, but rather to eliminate an
inefficient system that fosters misuse of companies for political
benefit. State-owned enterprises are often less efficient than
private sector firms and are a drag on the economy and a source
of corruption.
Despite commitments to the IMF, little progress has been made
regarding privatization. Only six state-owned enterprises have
sold shares to the public and in no case has more than 35 percent
of the capital been distributed. There has been no true
privatization resulting in transfer of control to the private
sector.
Vested interests of directors, commissioners, employees and
suppliers of state-owned enterprises oppose privatization. State
banks and state-owned companies play a key role in the
distribution of political favors.
Opponents of privatization contend that selling state-owned
enterprises is only justified to finance economic recovery.
However, many state-owned companies are unmarketable and the
others, when profitable, are not easily sold at prices that would
significantly help economic recovery.
Adversaries of privatization use false nationalism to argue
against selling "national assets" to foreigners. They suggest
privatization must be postponed until after economic recovery, at
which time the idea may be forgotten.
The owners of state-owned enterprise are the people of
Indonesia, not the government, and certainly not the directors,
commissioners and employees. State-owned enterprises were created
from taxes and it would be logical to return this money as a
benefit to taxpayers.
Valuation of equities is not exact and is subject to opinion.
It is unlikely that there will be consensus as to the "fair
value" of shares of state-owned companies. Some other basis must
be used.
It is possible to devise a system whereby privatization can
raise funds to assist the government's finances during the
recovery period, while avoiding the political traps of
determining a "fair price" or sale to foreigners. This can be
done by setting a reasonable price for the sale of shares to
taxpayers who would be allowed to purchase some shares of state-
owned companies every year and, within limits, use their purchase
receipts to pay future taxes. In effect, the shares would be
given to taxpayers who are, after all, the real owners. However,
by advancing payment of taxes by a number of years, the public
would finance the recovery budget.
Shares of state banks and state-owned securities companies,
stores, industrial companies and other ventures that have
competitors in the private sector should be entirely divested.
Government firms that are uneconomical and have no strategic
importance should be liquidated. State-owned companies with
strategic importance and without private sector competition may
be considered case-by-case.
Privatization must include the bank restructuring program that
has resulted in the government subscribing to most of the capital
of ailing banks. This subscription was accomplished by exchanging
government bonds for shares. This program has serious flaws:
* Medium and long-term rupiah government bonds are not
marketable at current rates in large quantities at a price close
to par. Therefore, ailing banks have not received funds to
finance recovery. If the bonds were to be sold at true market
value --- less than par --- the banks would be decapitalized and
the restructuring program would fail.
* The rupiah bonds are medium term with relatively high
interest rates. This presents a cash flow problem for the budget.
To solve the problem, it is necessary to recapitalize the
banks with bonds that can be resold in very large amounts on the
international market. There is no such demand for rupiah bonds,
but existing bonds could be substituted with marketable Brady
bonds. Brady bonds are a type of government security issued by
developing countries in financial difficulty, with a 30-year
tenure, guaranteed by 30-year, zero-coupon U.S. Treasury bonds.
Brady bonds have the largest international market for sovereign
obligations of developing countries.
Since payment of the principal is 30 years in the future, and
since dollar interest rates are generally less than equivalent
rates in local currency, the Brady bond puts less stress on
government budgets than alternative medium-term rupiah financing.
By providing restructured banks with Brady bonds, these banks
would be capitalized with usable funds and could finance
Indonesian businesses and stimulate employment. Restructured
banks could become profitable and the increased economic activity
would improve tax receipts.
Privatization, banking reform and capital market development
are linked. The key issue is the introduction of banking reforms
prohibiting borrowers from controlling banks and limiting
interest rates on guaranteed bank deposits.
To stimulate the capital market, fiscal incentives are needed.
To remedy defects in the bank restructuring program, ailing banks
should be re-privatized and Brady bonds should used as liquid
assets for bank recovery.
The writer is a former chairman of the Capital Market
Supervisory Agency (Bapepam).