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