Another corruption story has hit the front page of The Jakarta Post as this article was written. No surprise there. It happens rather a lot. This time it concerns a former Golkar Party lawmaker admitting in court, with admirable frankness, he took a tasty bribe to fund his 2004 election campaign.
The country has a reputation for graft and cronyism at the highest levels. There’s even an acronym for it: KKN, which stands for corruption, collusion and nepotism. Indonesia ranks a lowly 100 on the corruption perception index, according to Transparency International and sits among the likes of Russia in the World Bank’s ease in doing business index and is 42 places below China.
And yet Indonesia is far from a bad apple. The country posted 6.5% gross domestic product growth, comfortably above the 3.7% world average, with the domestic market driving the expansion. That said, exports reached a high of $203.6 billion in 2011, contributing to 26.3% of GDP.
Foreign direct investment grew 20% to a record $20 billion proving investors are happy to forgive Indonesia its sins of corruption, woeful infrastructure and flimsy contract law. And forgive they should. Indonesia is a sound bet for all but the most conservative investor.
But government policies are conflicting and this needs to be addressed before it becomes a hindrance to further growth. For example, the government wants to become less reliant on the outside, proposing currency regulations that increase the use of rupiah when doing business locally. This rubs against Bank Indonesia’s (BI) effort to lure more US dollars into the country and increase liquidity.
To be fair, overall, lending in 2011 increased by 24%, according to the central bank. But the cost of US dollar lending is rising, and that’s got CFOs rightfully worried.
Blame the paucity of US dollars available for lending on BI’s recent request that banks set aside 8% of their total foreign exchange holdings as reserves. The central bank is notoriously jittery about being short US dollars. It regularly intervenes in the FX market to dampen rupiah volatility and has built up a hefty war chest of dollars, standing at $112 billion as of the end of January this year, to tackle this.
The reaction is natural given Indonesia’s past but it appears that its policy is cramping the ability of banks to lend US dollars to corporations cheaply. Higher reserve levels and balance sheet restraints due to regulation and greater risk aversion are already troubling the global banks.
“Foreign banks in Indonesia were able to sell dollars at a very cheap rate compared to local banks. But today they are selling it a higher levels,” says Vincent Lim Aun Seng, CFO, at Indonesian-listed chicken feed producer Malindo Feedmill. “I would say as of now, the foreign banks are pulling all their US dollars back into Europe or the US. The local players are supporting the situation in Indonesia.”
Foreign bankers disagree with this assertion, arguing that local banks have shut shop on dollar liquidity.It’s more than likely both are holding back, carefully picking the right horses to back.
HSBC’s Nirmala Salli, head of trade and supply chain for Indonesia, admits that the bank is more reluctant to extend balance sheet in traditionally popular areas such as the textile and garment industry, which are now struggling to compete with the likes of China. On the other hand, the bank is keen to increase its exposure to coal and rubber, where business is booming and there are ample opportunities to earn healthy fee-based work on top.
Banks may be lending to some, but they’re not bringing down their rates in line with the central bank very quickly. The spread between the three-month dollar interbank lending rate and interest rate swaps, almost hit a three-year wide in January of 50.35bp. The three-month Jakarta interbank offered rate (Jibor), the average rate banks charge in the wholesale money market for rupiah, fell to its lowest in at least 15 years on March 15 at 4.115%.
The interest rate swaps provide the mean expectation for central banks’ policy rates. Therefore, the spread of Libor (or any benchmark) relative to a short-term interest rate generally reflects the funding liquidity risks in the interbank market.
“There is [an average] margin of 6.34% from the bank sector from their rates, so actually we see there is a problem with bank efficiency. Banks are not efficient and there is still room to cut their lending rates,” says Arlyana Abubakar, a manager at the bank’s foreign debt analysis and investor relations division, at BI.
The reason for this seems to stem from the government’s relationship with its four highly dominant state-owned banks. Indonesia’s state-owned enterprises ministry, as the controlling stakeholder of the state banks, sets profit targets for the banks. The position naturally leaves the state-owned banks in a tricky position to hit the targets and dole out juicy dividends back to the taxpayer rather than recapitalise and continue lending.
The central bank can’t compel banks to drop their lending rates but the measures it uses to cajole them are ineffective. To introduce greater price transparency it has requested all 121 commercial banks publish on a daily basis their average lending rates on their websites. This sounds sensible enough but who is going to spend all morning checking every bank’s website for the numbers?
A better way would be for BI to publish it on their website so CFOs, treasurers and the general public can more easily compare. Better still: break down the numbers depending on the size of the client. That would provide a more clear idea of where the good rates are to be found.
Fancy a Fight?
But if it is not punching it out with the commercial banks, the central bank is either fighting itself or competing with government policy. The bank’s recent export proceeds regulation is a prime example.
Effective January 2, exporters in Indonesia must repatriate their export proceeds onshore within 90 days of delivery of the goods. The prime driver is to bolster domestic liquidity of foreign currency in the domestic banking system but the central bank won’t go so far as to force that money to stay onshore — in line with its free foreign exchange movement policy. This creates a policy that lacks any real bite.
Furthermore, the new rules do not require the foreign currency to be kept in Indonesia for a specified period of time. So you could bring it in one day and transfer it out the next. It appears the central bank is pinning its hopes that the sheer bother of repatriating the money back into Indonesia will be enough for most CFOs just to leave their money onshore. Surely this is not as efficiently as introducing a capital control.
Local currency good. Foreign currency bad
The government also requires that the rupiah is used to settle financial obligations and other payment transactions taking place in Indonesia. There are exemptions, yet to be defined, to this law but the promotion of the rupiah in domestic transactions is the goal.
“Theoretically it would dry up US dollar liquidity and it’s tight as it is. By ensuring that you pay local currency there’s less dollars circulating in the market,” says Djaja M Tambunan, CFO of dual-listed mining and metals company Antam.
The central bank is understandably anxious about the consequences of this. Both institutions clearly have the same goal—to reduce rupiah volatility and capital outflows — but their methods leave markets confused to the point where they are not always taken seriously.
Another case in point: Indonesia’s central bank last year said it wanted to cap foreign ownership of banks at 50% – but it’s not enforcing this. In early April, DBS confirmed it has entered into an agreement to buy Temasek’s 67.4% stake in Bank Danamon Indonesia for $4.9 billion.
The news of DBS’s purchase has upset local investors who feel they didn’t get a fair shout for such assets but lawmakers have said there is nothing they can do. After the recent decree stipulating that foreign ownership in local mines could not exceed 49%, investors may be excused for wondering why certain sectors are protected more than others.
This all makes for a confused and messy picture of Indonesian governance. Indonesia has a lot to offer and is right to want to protect its jewels from jittery investors who will set flight at any sign of trouble. But investors need to feel that there is a consistency in policy and direction that won’t change. Likewise for a treasurer looking to hedge currency risk, it’s hard to know where to start
when the central bank and government ministries are talking the same language but walking in the opposite direction.