Trying to Return to the Investment Radar

Trying to Return to the Investment Radar By Lin Che Wei, CFA*

As the government endeavors to put its house in order for a better economy, the inter-related areas of debt, the banking sector, privatization and investment all need to be tidied up. While the medium term outlook has shown improvement thanks to political and macroeconomic stability, the country is still struggling to restore its banking system to good health, and the privatization program remains in jeopardy due to a lack of direction. The government focus on stimulating investment has yet to be borne out with results. Overall, the economic outlook is improving but it remains vulnerable to external shocks. It is important for Indonesia to adopt a more comprehensive strategy to revive its banking sector and enable privatization to proceed smoothly. Indonesia has been able to reduce the public debt level from 120 percent of Gross Domestic Product (GDP) at the peak of the crisis to 78% now. Still, Indonesia is in the process of managing its cash flow issues in its debt management; the amount of debt which will mature in the next few years is mounting. With the initiative to "reprofile" this debt, obviously Indonesia will have a more conducive macroeconomic environment. Despite the gains, one question remains unanswered - will real structural reform accompany the post-crisis period? Indonesia is shouldering a substantial amount of debt which will have to be amortized over the next generation, but it has failed to seize the momentum of the crisis to conduct wide-ranging structural reform. From the crisis point of view, the country will no longer need the International Monetary Fund (IMF) to guide its economic policy, but its commitment to adhere to structural reforms without pressure from multinational agencies has yet to be proven. Based on the UNCTAD report in 2002, Indonesia has recorded negative foreign investment flow since 1998, unlike Malaysia and South Korea which have turned around this aspect of their economic portfolio. In the medium term, I estimate Indonesia's investment climate to improve a little bit due to better macroeconomic factors and political stability. Natural resources and low value added industry will continue to be the areas of interest. It is a paradox that the government's declared determination to attract foreign investment is not complemented by proper treatment of existing investors. And the factors which contribute to weak foreign investment are well recognized. First, the biggest problem is political stability and security issues. With war raging in Iraq, Indonesia, the world's largest Muslim country, may well be perceived as a country laden with potential problems. The second factor is uncertainty concerning the volatile labor market, followed by the lack of coordination between the central and local governments concerning the implementation of decentralization, which often creates confusion for the investor. Fourth is the often confounding web of bureaucratic licensing and customs issues. Ranking fifth is woefully poor legal enforcement, brought to international attention through the Manulife, Polaris and Panca Overseas Finance cases. It's a sad and embarrassing fact that the courts are more often manipulated to protect powerful, well-connected parties than to uphold the law. These factors contributed to Indonesia's dismal ranking on the 2002 Index of Economic Freedom. Ranked 99 out of 161 nations, Indonesia was not only lower than the "to be expected" Asian neighbors of Singapore, Thailand, Hong Kong and Malaysia, but also trailed Cambodia and the Philippines, much smaller nations which have struggled with their own profound socio-economic woes. Yet, the lowly rank was a given when the very factors which undermine economic freedom - weak banking/financial infrastructure, disregard for property rights, rampant corruption - continue unabated in Indonesian business. The banking sector is likely to remain weak, despite the completion of recapitalization. We have yet to see a strong bank emerge, and mammoth sales of bad loans did not help the asset quality of the banks either. Sales of unrestructured loans back to the banking system carry the potential for bad debt in the future. Obviously, this is not a paramount concern for the Indonesian Bank Restructuring Agency (IBRA), which is more interested in closing down its operations as soon as possible. In the next three years to five years, the Indonesian banking system will continue to consolidate. After the gradual removal of the blanket guarantee, we are likely to see a further consolidation of the banking system through merger or liquidation of smaller banks. Unfortunately, loan growth will continue to focus on the consumer sector, with little assigned to investment purposes. With demand for investment continuing to be low and the banking system focused on resolving its low capital base, it's doubtful the banking sector will be able to resume its financial intermediary function soon. The focus for the government in the next few years will be selling its stake in the recapitalized banks, those institutions which it bailed out during the crisis. Regrettably, it seems the government is content to absorb the losses, but it is essential that it verifies the credibility of future owners. It's an issue that puts the government in a real dilemma because it could entail selling the banks to foreign parties, meaning that the largest national banks would eventually be partly owned or controlled by foreign shareholders under the government divestment program. Granted, the presence of foreign banks is positive to a certain extent because, as globally recognized international institutions, they would not resort to the wanton abuse of the banks for their own lending needs. By the same token, it is crucial to recognize that the objective of these banks might not be in line with the development policy of the government. In this aspect, a strong regulatory environment and accompanying policies are needed to ensure that the two objectives can be met. The privatization program remains one of the most controversial issues, with those with vested interests, politicians and trade unions quick to whip up nationalist sentiment to foment opposition. The biggest problem in proceeding with privatization is the lack of a blueprint for state owned enterprises (SOEs). In Indonesia, the government seems to be more interested in the final step of the privatization -- the selling process itself -- rather than the preparation. There are many prerequisites for effective privatization, ranging from its legal framework, legislative endorsement, the existence of a blueprint and long term strategy and, most importantly, the presence of a credible and non-corrupt government for its execution. Before the government starts embarking on privatization, the blueprint must be in place. Currently, there is only the plan left behind by former minister of state enterprises |Tanri Abeng, and that document is already outdated.. The fundamental objectives of the privatization and the basic guidelines determining which enterprises should be privatized must be discussed thoroughly and transparently with all related parties. The government must realize that privatization is not a quick fix for what ails state-owned enterprises through a change of ownership. For the long term good, it needs to focus on creating a more competitive environment in the enterprises through sincere efforts to eradicate corruption and establish proper regulations.

The writer is a chartered financial analyst based in Jakarta.

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