Wednesday, October 25, 2006

Positive Perceptions, Uncertain Investment

No. 08/VII/Oct 24 - 30, 2006
Tempo Magazine, Cover Story
Mirza Adityaswara
Banking and capital markets analyst.

CAN the rise and fall of stocks in Indonesia serve as a barometer of the success or failure of the government? Of course not. Public ownership of shares and bonds is still at a very low level compared to bank savings. But the performance of the stock exchange, the rupiah and bond yields, could become a barometer of foreign investors’ perceptions of the government’s performance.

There are two types of foreign investor, portfolio investors and direct investors. Portfolio investors put their money into liquid assets and tend to take a short-term view. Meanwhile, direct investors are more conservative because once they invest in a country, it is difficult for them to withdraw quickly.

What about the perception of foreign portfolio investors regarding the performance of the SBY-JK government in its first two years? Seen from the rise in the stock index, the stability of the rupiah exchange rate and the improvement in the yield of State Bonds (SUN), we can conclude that foreign portfolio investors currently have a positive perception of Indonesia.

From October 2004 to October 2006, the rupiah remained stable in the range Rp8,000-Rp9,300 to the US dollar, although it did weaken to Rp12,000 in the third quarter of 2005. The stock index rose 81 percent from 852 to 1,549, and the yield for 10-year State Bonds remained stable at 11 percent, although it did improve to 10 percent in the first half of 2005 and worsen to 16 percent in the third quarter of 2005.

The improvement in Indonesia’s credit rating and the fall in the benchmark Bank Indonesia rate led to the hope that the Indonesian economy would recover in the second half of 2006 and into 2007. The sales figures for motorbikes, automobiles and cement in the second half have started to show a slow recovery.

Foreign ownership of SUNs also rose from Rp10.7 trillion in December 2004 to Rp58.1 trillion in August 2006. This means that Rp47 trillion of foreign funds flowed into bonds in the last two years on the SUN market. And this does not include the inflow to the stock exchange.

The government has managed to use this money to narrow the budget deficit caused by the shortfall in domestic funds. But, on the other hand, the size of this foreign investment portfolio in Indonesia also poses a risk to the stability of the financial system. If investor perceptions turn negative, the Indonesian financial markets will feel the shock.

So which is the more dominant in terms of influence on the Indonesian financial markets in the two years of the SBY-JK government: domestic or foreign factors? Of course, it is domestic factors. But we cannot ignore the rate of economic growth of the United States and China or the Japanese economic recovery, or the rise in mining and forestry commodity prices, which also have a positive effect on Indonesia’s exports, leading in turn to a positive effect on Indonesian financial markets.

After security issues, foreign investors and credit rating agencies pay most attention to macroeconomic stability and economic reforms. Government spending totals, the trade balance, the debt ratio and inflation in Indonesia are compared with the figures in other nations. So there is nothing wrong with the government trying to keep the budget deficit at less than 1 percent of GDP, reducing debts, maintaining the visible trade surplus and reducing inflation. The paying off of the debt to the International Monetary Fund (IMF) without causing tremors in the market is an achievement deserving a thumbs-up.

The financial markets were shaken in the third quarter of 2005 when the rupiah weakened to Rp12,000 to the US dollar as a result of concerns over government spending after oil prices and government subsidies soared. The result was the tough decision to drastically increase fuel prices.

The markets welcomed this move, but now we are seeing the effects: people’s buying power has fallen drastically and poverty has increased. We now realize that the 2005 rise in fuel prices was too steep, far exceeding the ability of the people to pay.

Economic reforms, improvements in governance and the restructuring of state-owned enterprises (SOEs) are also factors under constant scrutiny. The efforts to stamp out corruption are a plus point for the SBY government that its predecessors did not have. These efforts have a short-term negative impact on the economy as many government projects have been delayed. This is a learning process for the good of the Indonesian people in the future.

What feels slow now is the restructuring of the SOEs. We have gone from a regime that was very pro-privatization to one that is anti-privatization. Neither is good. Now, many SOEs cannot expand because the government has no funds to inject. On the other hand, SOEs are unable to seek funds on the capital markets because the government does not want to see its shareholding reduced. As result, our SOEs are being left behind in foreign and domestic markets. Is this what we want?

In the last two years, the only SOE restructuring that has succeeded has been that of Bank Mandiri, because the management were serious about putting the business right and calling in bad debts. Next year, the government will have to decide if it is willing to see its shareholding in BNI diluted because the bank needs Rp3 trillion of capital to meet the requirement that its core capital ratio reach 10 percent by the end of 2007.

The challenge of 2007 is the weakness of the US economy and the narrowing difference between Indonesian and US interest rates. If the US economy slows down more than economists predict, there will be a negative impact on global financial markets. In terms of value, Indonesian shares will still be attractive in the eyes of investors, but they will no longer be cheap compared to, for example, Thailand.

And we should note that investor optimism regarding the financial markets could turn into pessimism if foreign and domestic direct investment, or investment in infrastructure, does not materialize. Without infrastructure in the form of electricity, water and satisfactory roads, it is difficult to hope for economic growth of more than 6.5 percent.

Total domestic investment for the first eight months of this year amounted to only 133 projects worth Rp11.8 trillion—a fall compared to the 151 projects in the same period last year. And foreign investment projects totalled only 628, compared to 633 from January-October 2005. The total value of foreign investment was only US$3.9 billion, less than the US$7.2 billion over the same period last year. Most of the foreign investment was not new projects, but existing investors expanding their businesses.

A report from the World Bank and the International Finance Corporation entitled Doing Business 2007 shows that in terms of investment climate, Indonesia is ranked at 135 of 174 countries. This is woeful. It does state that Indonesia has cut the company registration process from 151 days to 97, but our competitors have also made improvements, and they are more efficient than Indonesia.

The top position is held by Singapore, while other ASEAN nations are ranked higher than Indonesia. For example Thailand is at number 18, Malaysia at 25, Vietnam at 104 and the Philippines is at number 126.

For businessmen, the problems of wages, the number of charges, anti-business bylaws and the euphoria of decentralization add to the confusion. It is no surprise to see the recent trend of Indonesian businessmen expanding their businesses overseas, in countries such as Singapore, China and Vietnam.

If domestic businessmen have lost faith in the investment climate in their own country, how can we hope that foreigners will put their money here?


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