Why privatization fails in Indonesia

Why privatization fails in Indonesia

Reiner S.
The Jakarta Post
Jakarta

When popular leader Megawati Soekarnoputri was elected as the
country's new President late in July, followed by the appointment
of her confidant Laksamana Sukardi as State Minister of State
Enterprises, there were high hopes Indonesia might finally be
able to push ahead with its privatization program, which had
stalled over the past three years.

Unfortunately, progress has been insignificant mainly due to
the same old obstacle: opposition from the House of
Representatives and groups with vested interests in the firms
such as politicians, employees, company management and political
parties.

For the past two consecutive years, the government has set an
identical annual privatization proceeds target of Rp 6.5 trillion
to help finance the state budget deficit. A list of 16 state-
owned enterprises (SOEs) has been proposed for privatization.

But no transactions were concluded last year, and for 2001 the
result was almost identical, except that the government managed
in the later part of the year to sell shares in the publicly
listed state-owned telecommunications firm PT Telkom and non-
listed plantation firm PT Socfindo, raising around Rp 3.5
trillion in cash for the state budget.

Consequently, the government has had to cut down on
development spending and other expenses.

Two state-owned pharmaceutical firms PT Indofarma and PT Kimia
Farma were privatized earlier this year via an initial public
offering, but the proceeds went into the two companies, not the
government's coffers.

For 2002, the same list of SOEs has been proposed and the
proceeds target is still set at Rp 6.5 trillion, but this time
only Rp 3.95 trillion would be used to finance the budget deficit
while the remainder Rp 2.55 trillion would be used to redeem
government bonds in a bid to help avoid a fiscal disaster as most
of it would mature in 2004.

Will the government privatization program work this time?

There are various reasons why the privatization program has
failed during the past three years, but the first and foremost is
the strong opposition from the House, politicians and other
groups with vested interests. Other reasons include political
uncertainty and lack of preparedness.

The opponents of privatization have various reasons ranging
from concern over foreign domination in strategic national assets
to unfavorable market conditions, which would put a downward
pressure on the price of the assets.

Analysts, however, said that certain politicians or company
management had their own personal agenda in rejecting the
privatization program: to retain their lucrative cash cows.

The government admits that the lack of political support has
been the main obstacle to the country's privatization program.

"The privatization program needs strong political support to
be successful," said finance minister Boediono.

The biggest blow to the country's privatization program
occurred last month in Padang, West Sumatra province, when the
local administration backed by a certain group of politicians and
local leaders unilaterally took over PT Semen Padang, a key unit
of the state-owned PT Semen Gresik. The takeover was in protest
over the government's plan to sell another 51 percent stake in
the latter to Mexico's Cemex SA de CV, which already owns a 25
percent stake. Padang is the home base of Semen Padang.

Although the West Sumatra provincial administration later
canceled the damaging move, it had dealt a major blow to foreign
investor's confidence including the World Bank, the country's
largest multinational donor. There has been concern that the move
could trigger similar action by other provinces toward other SOEs
or foreign companies operating in remote areas.

For the past two years, the government has been trying to sell
a majority stake in Semen Gresik to Cemex, the world's number
three cement producer. But the strong protest, not only from West
Sumatra but also from South Sulawesi, the home base of another
Semen Gresik unit PT Semen Tonasa, and from company employees and
top management caused delays in the program.

The government now fears that Cemex might completely back out
of the purchase plan due to the legal uncertainty triggered by
the various protests. There has been no word yet from Cemex.
Laksamana said that if Cemex quits the plan, the government would
have to seek other buyers. But this would be a very difficult job
given the bad record so far and amid the current global economic
slump.

Some said that the widespread protest against the Semen Gresik
privatization program was partly caused by the lack of
information provided by the government to the local people and
lawmakers about the importance of the transaction.

Others also criticized the central government particularly
Laksamana and Minister of Home Affairs Hari Sabarno for being
indecisive in taking action against top officials of local
administrations and companies who had campaigned against the
privatization program.

The government must be more aggressive in making privatization
campaigns and dissemination of information on the benefits of the
program to the public and local politicians to win their support.
It must also improve the transparency and accountability of the
program.

"There must be a more intensive dialogue with the
stakeholders," said economist Didik J. Rachbini of Jakarta-based
private think tank INDEF.

"The (local) government, the politicians and the people in
general must understand that the privatization program is a
crucial part of the country's economic reform aims to achieve
sustainable economic recovery," he added.

In addition to raising proceeds to help finance the state
budget, there has been stronger evidence that privatization also
improves the performance of SOEs and the overall economy.

International experience shows that privatized firms display
improved efficiency, profitability, employment and growth, the
World Bank said in a recent report.

There are more than 160 SOEs in Indonesia, and according to
the results of a 1997 audit, more than half are in a weak
financial condition. At the end of 1999, accumulative losses of
the SOEs reached a staggering Rp 47.65 trillion.

The poor performance of the SOEs is due to inefficiency, poor
management and corruption. This problem will continue to become a
burden to the state unless it is resolved, which is one of the
aims of the privatization program.

"More importantly, cross-country evidence indicates that for
every 1 percent of GDP (gross domestic product) privatized,
overall GDP and employment climb by about 1 percentage point and
0.25 percentage points respectively the first year, and 0.8
percentage points and 0.5 percentage points in the second. And
these gains extended into the years beyond," the World Bank said.

Opponents of privatization often urge that the sale be delayed
amid the current unfavorable market condition, arguing that the
asset price could rise later on. But the problem is that there's
no guarantee that the price will increase particularly amid legal
uncertainty and the government poor track record in implementing
the asset sale program.

"It makes financial sense to delay asset sales only if asset
prices are expected to increase faster than the rate of interest
-- about 17 percent a year currently. Asset values in Indonesia
have not been rising anywhere near this rate, and in many cases
have fallen," World Bank said.

In other countries, privatization programs start by selling
smaller SOEs operating in a competitive industry to develop a
good track record and credibility, and then move to larger
transactions. However, in the case of Indonesia it has no such
luxury due to the pressure on the state budget suffering from a
huge deficit. The government must quickly privatize large SOEs to
plug the hole in the budget.

In short, the case for moving ahead with the privatization
program is compelling.

For eyebox:

SOEs for sale in 2002
_______________________________________
Fertilizer manufacturer PT Pupuk Kaltim
Hotel/office building operator PT Wisma Nusantara International
Surveyor firm PT Sucofindo
Plantations firm PTPN II
Retailer PT Sarinah
Coal mining firm PT Tambang Batubara Bukit Asam
Steelmaker PT Krakatau Steel
Bank Mandiri
Airport operator PT Angkasa Pura II
Cement maker PT Semen Gresik

Telecommunications firm PT Indosat