Monday, September 14, 2015

Crisis or no crisis? Rethinking Indonesian financial market developments

Indonesia’s post-2020 climate plan raises questions President Jokowi’s long and winding road to economic reform View Point: Using connectivity to put the horror of 9/11 behind us News, rumors and speculation about an impending crisis are getting louder each passing day.

And there is some reason to think that indeed we are on the brink of a crisis:

The rupiah is among the worst performers in the region, having depreciated 18 percent since September 2014 while the main stock index has lost 17 percent during the same period, and gross domestic product (GDP) growth has stalled at 4.67 percent, well below the official target of 5.7 percent.

The steady decline in the value of the rupiah has triggered painful memories of the 1998 crisis and fears of a similar crisis happening. Even though the government has repeatedly tried to reassure the nation that any possibility of a crisis is remote given that the posture of the economy today is very different compared to that of 1998, many are still unconvinced.

Apparent infighting between members of the President Joko “Jokowi” Widodo administration, including law enforcement and the judiciary, is one reason for the skepticism. If a crisis really were to strike, how could a divided government stand? Crisis calls for a solid, cohesive and swift response, not just calming words or, worse, conflicting statements from top officials.

Another important reason for the markets to discount the assurances from the government is perhaps because the reality is not as reassuring as the government portrays it to be. Although the balance sheet structure of most banks and many corporations in Indonesia is in better shape than it was in 1998 or 2008, one can argue that the same forces that shaped the economy during those years might have created new vulnerabilities that could can be just as harmful as previous economic and financial weaknesses (see for example the article entitled “A protocol for boom management is needed”, The Jakarta Post, Sept. 8).

Moreover, faced with external shocks, structural weakness stemming from the relative underdevelopment of the financial sector poses a great challenge for the government.

Some statistics show that despite a series of reforms undertaken in the aftermath of the 1998 and 2008 crises, financial development in the country is still weak. Indonesia ranks 14th out of 16 countries surveyed by MasterCard for financial literacy. At 0.15 to 0.30 percent, the stock market participation rate in Indonesia is negligible and hence not surprisingly foreign investors own about 65 percent of the total stock market and 38 percent of Indonesia sovereign bonds. Clearly there is room for improvement.

But as we expand the reach and depth of financial markets, there are two caveats that we would do well to heed. First, we must not forget that financial markets are only a means to an end. The goal with financial markets is to provide financing and risk management mechanisms for the real economy. When the financial sector grows out of sync with the real economy then something is wrong and when the time of reckoning comes the contraction in the financial sector might spill over to the real economy. Indeed, something is wrong when every major station and news outlet dutifully displays a running ticker and quotes in their primetime programs, websites and newspaper front pages. Why should the daily fluctuations in the prices of shares be so important? Surely the value of a company does not fluctuate as widely as the movements in its share prices would suggest.

For example, the share price of PT Semen Indonesia Persero Tbk (SMGR) has declined from Rp 16,200 (Jan. 5) to Rp 8,800 (Sept. 8) apiece. But does anyone really believe that the value of all the plants, machinery and other assets, even the future growth prospects of the company, has been reduced by almost a half? And yet the whole cement industry is built on this phenomenon and trading shares back and forth is promoted as increasing the liquidity of the market. Sadly, even the regulators have blindly encouraged the proliferation of this anti-investment mentality.

When the public perceives that the stock market is nothing more than a fancy, highly celebrated casino and that investing in stock is just another form of gambling, then the average working men and women will be less willing to invest and the real economy will suffer. To change this perception, to educate and to inform the public is the task of the regulators and all finance professionals alike.

The other thing to remember is that financial deepening is only one aspect of financial development. The depth of a market refers to its size and liquidity. But there are other elements to financial development, including the ease with which individuals can access financial services and how efficiently institutions and the market operate (International Monetary Fund staff discussion notes 15/08, May 2015). While we pursue deeper financial markets, we must also expand the reach of financial services and increase the efficiency of the industry.

In the last decade or so, the expansion of retail banking operations and financing companies is highly visible. Furthermore, the rise of Internet and mobile banking in recent years has created new markets and given access to basic banking services to millions of Indonesians. Provision of credit and loans to small and medium enterprises is one of the drivers of growth and the good news is that this growth generally continues regardless of whether the stock market is in a bullish or bearish mood. In this respect, humble entrepreneurship is far more important than the blink of high finance. The culture and spirit of entrepreneurship should be cultivated, encouraged and stimulated. Start-ups and small businesses should be provided with easy access to all available financing venues and be granted tax incentives to further foster innovation and growth. In the past, small and medium enterprises (SMEs) have proven that they can weather economic storms and thus it is in everyone’s best interests to devote more resources to this segment.

In addition to better access to financial services, we must also strive to improve the efficiency of financial markets and institutions. Our capital market is growing, but there is ample room for greater transparency and higher efficiency. In addition, low-cost investment products which benefit most investors are still very rare. In the banking sector, inefficiency is a major issue which has never been resolved. Banks in Indonesia can get away with high operating costs thanks to a still higher interest margin. But inefficiencies are not exclusive to the private sector: Despite years of so-called bureaucratic reform initiatives, government agencies and organizations are still largely inefficient and corruption continues to be a major challenge.

Financial development is essential if we are to build an economy that can withstand crises. Financial development does not mean only bigger and more liquid financial markets. It also means greater access to multifaceted financial services which are provided in an efficient manner. As with other worthy goals, financial development requires goodwill, strategic thinking and hard work. A well-developed financial sector is no panacea, but it will definitely contribute to a more robust and resilient economy.

The writer Glenn Polii, Jakarta is a staff member at the directorate general of taxation at the Finance Ministry.

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