Why the capital market in Indonesia is underdeveloped

Why the capital market in Indonesia is underdeveloped Lili Yan Ing  ;  Economist for Economic Research Institute for ASEAN and East Asia (ERIA); Lecturer at the Faculty of Economics, University of Indonesia

JAKARTA POST, 30 Maret 2015

                                                                                                                                     

                                                                                                                                                           

While Indonesia has become one of the sexiest investment destinations in the emerging economies, one of the backbones of growth drivers — the capital market — is still creeping. Southeast Asia recorded a strong economic growth over the last two decades with an annual average growth of 5.7 percent from 1990 to 2014 and the strong economic growth in the region was accompanied by improved business confidence. In February 2015, the average business confidence index of Southeast Asian countries was 69 and Indonesia recorded 105, which was among the top in the world while the average of the developing countries was 76 (Note: China (115), Germany (106.7), Malaysia (86), Thailand (49) and the Philippines (34), France (76), US (52), Japan (12), Korea (74), India (57), and other developing countries in LAC, Brazil (46) and Peru (54)). In addition, Japan, the largest investor in Southeast Asia, has placed Indonesia among the top three investment destinations for more than a decade, and a number of investment banks have rated Indonesia with BBB since 2012. Strategic portfolio investments usually follow long-term investment behavior. So why is the capital market in Indonesia still underdeveloped? There are three indications that Indonesia’s capital market is still underdeveloped. The first indication is that the number of publicly listed firms in Indonesia in 2014 was still relatively low, totaling only 506 as of 2014 compared with that in its peer countries such as in China (2,613), Singapore (775), Malaysia (905) and Thailand (613). The second is that in terms of the total value of stocks traded, Indonesia recorded the second-lowest figure of countries in the region, according to the World Development Indicators, 2015. The third indication is that firms in Indonesia still do not rely on equity or stocks as their sources of investment. Based on the Enterprise Survey, about 86 percent of investment was financed by internal revenues. Only 3 percent of investment is financed by equity and 6 percent by banks. But, then, what are the root causes of the underdeveloped capital market in Indonesia? First, the limited number of instruments (stocks, bonds, rights, warrants, futures, mutual funds) and derivative products. Domestic companies and local retail investors are familiar mostly with traditional banking products and less exposed to capital market derivative products. Second, the low interests of firms to “go public” as a result of problems related to the tax system. When firms “go public”, they have to disclose their financial statements, including tax payment statements, while many companies still prefer to enjoy “invisible tax gains” from the inefficient tax system in Indonesia. Many businesses have cited tax administration and the tax system as one of the biggest barriers to doing business in Indonesia. Individual investors also prefer to invest in fixed assets such as property and land as there are no significant progressive taxes on property and land in Indonesia and in deposits at banks because of the relatively high interest rates offered by banks. Banks in Indonesia recorded an average net interest margin of 5.3 percent from 2000 to 2014, which was the highest in Asia, compared with South Korea (1.7 percent), Malaysia (2.8 percent), the Philippines (4.1 percent) Thailand (4.4 percent) and Vietnam (3.4 percent) (International Financial Statistics, 2015). ●

Indonesia in 2014 : Java, ‘Jalan’ and Jokowi Lili Yan Ing  ;   An economist at the Economic Research Institute for ASEAN and East Asia (ERIA), Lecturer at the University of Indonesia

JAKARTA POST,  17 Juli 2014

                                                

The Indonesian economy in 2014? No more wait and see. Three “Js” should be considered as top priorities in the next quarters. The first J stands for Java. Java has been named a “manufacturing corridor”, but very little action has followed. We can count by hand the number of industrial areas on the island, though it is the country’s supposed manufacturing hub. The manufacturing sector provides the highest value jobs for graduates of secondary school, which will contribute to the largest portion of Indonesia’s labor force in the coming decade. Moreover, the development of the manufacturing sector will have multiplier effects on the development of agriculture and services. In 2012, Indonesia provided 27,321 hectares for industrial areas or estates, while Thailand had 18,162 ha and Vietnam had 17,815 ha. In terms of size of country, industrial areas in Indonesia were only 0.012 percent of total land, versus 0.036 percent and 0.058 percent in Thailand and Vietnam, respectively. So the industrial land area of Thailand and Vietnam is three times and 4.8 times respectively larger than that of Indonesia. Java, the main hub for the manufacturing sector, accounted for 82 percent of industrial areas in Indonesia, ranging from Banten to East Java, while the rest are located in Riau Islands, particularly Batam and Dumai, with a smattering in other areas such as Medan, Makassar, Bitung, Bontang and Palu. The same old story of adequate infrastructure (electricity, water, connectivity) was repeated by foreign businesspeople, as shown in a survey by Japan’s Jetro. The survey highlighted low utilization of industrial areas outside Java. On top of that, a weak legal system has also been a major concern in doing business in Indonesia. To move forward in the short run, the government should focus on improvement of industrial areas in Java with consideration paid to labor availability, proper infrastructure and dry ports, with special focus on clusters of industries (e.g. electronics, automotive, garments, chemicals, and so on.) The second J stands for Jalan (road). Indonesia should increase the quantity and quality of its roads. The 416-kilometer Gyeonbu Expressway from Busan to Seoul in South Korea has largely been regarded as a successful output of Korean industrialization policies. The highway has been commended as one of the key instruments in bolstering exports from Korea — delivering products from the country’s provinces to the main export gateway of Busan. Exports of goods and services contributed about 56 percent of Korean gross domestic product (GDP) in 2013. In Indonesia, there are no such highways that connect the main industrial estates to the main export gateways or distribution centers. Jakarta’s outer ring road has been completed, but covers only 65 km. The Tangerang-Merak (the main port) highway is 73 km, and Jakarta-Cikampek is another 73 km. The longest highway, scheduled to be completed by 2015, will be the Solo-Kertosono or Trans Java toll road with a length of 179 km. The main issue is actually not about the length. The more important thing is how industrial and business areas are connected, and how these areas connect to the main export and import gateways (ports and airports). Indonesia, being a vast archipelago, should also develop a more efficient multi-mode transportation system and improve inter-island shipping services. The third J stands for Jokowi (Joko Widodo, the presumptive president-elect). One thing we can learn from him is he has shown a simple and applicable yet very effective way of bureaucratic reform in Indonesia. What does Indonesia need in bureaucratic reform? First, place the right people in the right places based on their professionalism. During his tenure as the mayor of Solo and governor of Jakarta, Jokowi has selected and placed government officials fully on the basis of their professionalism and competence. One simple example is that he regularly conducts an open selection process to elect a head of district. Another example is when he selected a physician who had led communal health services for several years as the head of district where children health was the main issue. Second, he set performance indicators for outputs and services as well as persons in charge to provide services. Third and the most importantly is evaluation. Jokowi has made performance appraisal simple by reviewing and looking at the outputs of the officials being appraised. He often makes surprise visits to see for himself how public services are delivered — how schools, hospitals and public transportation facilities are run. And he acts firmly and quickly on the findings of his field visits. While long term investors still put high hope for long-run Indonesian development, Indonesia should take bold actions in the coming months in expanding and improving the quality of industrial estates, including improving transportation and logistics in those areas and from those areas to the main export/import gateways and continuing bureaucratic reforms particularly in trade and investment procedures. Business players and investors can no longer just wait and see. ●

Simplifying business licensing

Simplifying business licensing Lili Yan Ing  ;   A Private Sector Development Economist at the World Bank Office, Jakarta, A Lecturer at the University of Indonesia

JAKARTA POST, 13 Februari 2013

Indonesia is not the easiest place in the world in which to do business, as confirmed by the country’s ranking of 155th out of 183 countries in the World Bank’s Doing Business 2012 report. One starting point from which the government could start to make things a little easier would be by reforming business licensing — a key to improving the investment climate. It seems that complex business licensing procedures discourage firms from becoming registered, giving rise to difficulties later in their accessing finance from formal financial institutions and constraining productivity. Across sectors, this can suppress the establishment of new firms and therefore the creation of new jobs, dragging down overall economic growth. While simplifying business licensing does not necessarily raise the total value of investment, a recent study by the World Bank suggests that simplifying business licensing in Indonesia may increase the number of small and medium enterprises (SMEs) being set up. This is consistent with the finding that there is a correlation between the number of SMEs per thousand inhabitants and the costs of starting a business. The logic is that easier licensing procedures could encourage firms to become registered and thereby help firms to access finance from formal financial institutions, supporting expansion particularly for SMEs. Getting access to finance should help to raise firms’ productivity, allow expansion and generate economies of scale, thus providing a boost to job creation and economic growth. When comparing plant size distribution between Indonesia and a number of other emerging countries, we find a striking feature of very few medium-size firms in Indonesia, the so-called “missing middle”. For example, the percentage of small firms is larger in Indonesia, a huge 93 percent, versus 37 percent in Brazil. Small firms in Vietnam and the Philippines constitute about 60 percent of total firms. Meanwhile, medium-size firms constitute only 5 percent of all manufacturing firms in Indonesia, compared with 47, 27 and 28 percent in Brazil, Vietnam and the Philippines, respectively. In addition, in Indonesia more than 30 percent of the sample firms are unregistered. There seems to be several reasons why some firms prefer to remain small, one of which is related to the desire to evade taxation and inspections, while another is that the costs of being registered outweigh the benefits. Some experts argue that excessive regulation and licensing is a factor in keeping firms small and informal. In Indonesia, licenses such as company registrations (TDP) and/or trade licenses (SIUP) are used as one of the requirements to obtain financing from financial institutions. Therefore, it is surprising that so many firms prefer to remain unregistered. The burdens relating to poor licensing policy appear to be a major issue for businesses across Indonesia, forcing them to remain informal or deal with the costs of compliance. Although some licenses are processed at the national level, most are processed at the local level, especially those related to physical permits, sectoral licenses and business registrations. Among licenses and permits, construction permits (IMB) and nuisance permits (UUG) are perceived as the most onerous to obtain by firms. There are two main reasons for the complexity in business licensing in Indonesia. First, a plethora of regulations referring to buildings, nuisance and the environment creates overlapping rules and confusion in implementation. Second, limited technical standards for building construction or design safety often leads to “negotiations” with officials over standards. The situation can be even more complicated where provincial and municipal/district governments have the capacity — whether de jure or de facto — to introduce new regulations. While Indonesia has made some progress in reforms helping business start-ups, it is still far behind its peers like Malaysia and Thailand. Indonesia ranking of 155th out of 183 countries in starting a business, compares with Malaysia and Thailand which ranked 50th and 78th, respectively. Starting a new business in Indonesia is relatively more difficult compared with its regional peers. It takes about 45 days with eight procedures to start up a new business in Indonesia, while it takes an average of only 38 days with seven procedures in the Asia Pacific region. In Malaysia, starting a business only takes six days and four procedures and costs 16 percent of average income per capita, while in Thailand it takes 29 days and five procedures and costs 6.2 percent of income per capita. Meanwhile, Indonesia trails well behind costing 18 percent of income per capita. The government should continue its efforts to simplify business licensing. Simplification is about limiting licenses to those that are justifiable. Also, many firms complain that in order to obtain licenses they are pressured to join business associations. So, one quick-fix would be to issue an official announcement explicitly stating that joining a business association is an option but not a requirement for starting up a new business. In addition, efforts in the medium term should focus on improving coordination between government agencies and clarifying the roles of central and local regulations both horizontally and vertically. Simplifying business licensing is no silver bullet for increasing economic growth in Indonesia. However, relatively cheaper and faster business licensing seems to have a positive effect on the number of SMEs being established and therefore on job creation. However, more work is necessary to better understand the precise impact of regulatory reforms on SMEs — Indonesia’s main job creators — as urgent as the need to simplify is. In view of this, simplifying business licensing in Indonesia should be considered a first step toward unleashing the potential for more business start-ups and act as a key to unlocking broader investment climate reform. ●

Indonesia in economic cooperation fever

Indonesia in economic cooperation fever Lili Yan Ing ;   An Economist at the Economic Research Institute for ASEAN and East Asia (ERIA), A Lecturer at the University of Indonesia

JAKARTA POST, 04 Februari 2013

As most of the regional Free Trade Agreements (FTA) in South East Asia started in the early 2000s and came into effect in January 2010, additional economic cooperation, namely Regional Comprehensive Economic Partnership (RCEP), Trans Pacific Partnership (TPP) and Asia Pacific FTA (APFTA) have become an open notion.  By December 2011, APEC members have 110 Regional Trade Agreements/Free Trade Agreements implemented (44 of which were intra-APEC RTA/FTAs) and 129 RTA/FTAs signed (49 of which were intra-APEC RTA/FTAs). Indonesia itself has engaged in no less than six bilateral and regional FTAs: ASEAN Free Trade Agreement (AFTA), Indonesia Japan Economic Partnership Agreement (IJEPA), ASEAN-China FTA (ACFTA), ASEAN-Korea FTA (AKFTA) as well as complementary top-ups of bilateral agreements with its dialog ASEAN partners, namely India (AIFTA) and Australia and New Zealand (AANZFTA).  There are at least two main effects of an economic cooperation, here referred to as FTA.  First is a direct effect. The agreements generally focus on tariff reductions and will increase trade flow as well as decrease prices for consumers. In addition, an FTA’s rules and trade policy bindings will reduce uncertainty and expected cost, which may be more important to the investment decisions of firms than a reduction in the applied tariff affecting existing trade flow.  Second is an indirect effect. It is asserted that FTA has dynamic effects such as expanding business scale, increasing product variety through sharing information and the latest innovations among business, as well as moving domestic policy reforms forward.  While the effects of an FTA on expanding business scale, increasing product variety and pushing forward domestic policy reforms, might not be feasible, its effects on trading flow is quite noticeable, as illustrated by the number of Indonesian businesses using the facilities of trade agreements. There has been a dramatic uptake in the use of tariff preference by Indonesian exporters.  To enjoy a FTA, the use of Certificate of Origin (COO) among Indonesian firms to enter markets with preferential access has increased, which has been accompanied by increases in the value of exports.  The total number of COOs issued by Indonesia — within AFTA, IJEPA, ACFTA, AKFTA and AIFTA framework — has increased from 26,085 certificates in 2007 to 205,775 certificates in 2010, which has been accompanied by an increase in the value of exports using COO facilities from US$1.9 billion in 2007 (2 percent of total value of non oil and gas exports) to $19.9 billion (16 percent of total value of non oil and gas exports) in 2010 (author’s calculation based on data from Ministry of Trade of Republic of Indonesia, 2011, please note: There was no sufficient data on the use of COO of AANZFTA).  The increase of the use of COO shows the efficacies of trade agreements and that the Indonesian private sector is benefiting from trade agreements.  However, learning from the implementation of FTAs, there are at least two main constraints to optimize the use of existing FTAs. First, the reciprocal tariff rate treatment can be an extremely complicated style of tariff concession. Second, the costs for compliance with rules of origin (ROOs) naturally exclude a large number of firms to use the FTA scheme in their trading.  It is estimated that the costs of compliance with ROOs are ranged between 3 and 5 percent of the final product prices. As a result, only a limited number of firms, particularly the large-sized firms can enjoy the use of a preferential tariff schemes (small and medium enterprises [SMEs] may enjoy Free Trade Agreement facilities if they are linked to large firms either as suppliers and/or customers).  While the overall trade and investment performance of Indonesia has improved in recent years, there is considerable room for further improvement in business licensing, customs clearance, finance and logistics services to further accelerate trade and investment, and moreover, how to optimize the use of economic cooperation to improve overall welfare. ●

Indonesia economy 2012: Bright, but can it be sustained?

Indonesia economy 2012:

Bright, but can it be sustained?

Lili Yan Ing & Chatib Basri, LECTURERS AT THE FACULTY OF ECONOMICS,

UNIVERSITY OF INDONESIA

Sumber : JAKARTA POST, 29 Januari 2012

The Indonesian economy has shown its resilience in the face of consecutive global crises since 2008 by maintaining growth at an average of 6 percent from 2008 to 2011. Even though the global economic outlook continues to deteriorate and financial markets continue to be volatile, Indonesia is not highly integrated into the world market and the real economy remains little affected. It is even expected to record growth of around 6 percent in 2012, but will it be sustained?

Please keep in mind that, firstly, the Indonesian economy is still heavily reliant on the domestic market and less on exports and investment, with around 60 percent of GDP attributable to domestic consumption. Secondly, Indonesia’s exports have been largely dominated by natural resource-intensive commodities. In fact, the contribution of such exports (agricultural commodities and mining and minerals) to total export value has increased from 18 percent in 2000 to 42 percent in 2010, while that of exports of manufactured goods has decreased from 35 percent to 20 percent over the same period.

Why could relying heavily on natural resources be a problem for sustained development even though Indonesia has a comparative advantage in those products?

First, relying on natural resource-intensive exports could lead to volatile growth as prices and production of these commodities are relatively volatile. Second, natural resources do not generate much employment, unlike manufacturing industries and related services.

Even though these enclave sectors typically operate at very high productivity, they cannot absorb the surplus labor from agriculture. Moreover, compared to these sectors, the agriculture and mining sectors offer relatively lower wages for secondary school graduates who make up the bulk of Indonesia’s labor force (World Bank Economic Quarterly, December 2011).

Last, there is little transfer of technology in resource-intensive sectors. Economies with a revealed comparative advantage in primary products have less of an advantage in the sense that development in the natural-resource sector brings less structural transformation compared to manufacturing industries. The larger the proportion of natural resources in exports, the smaller the scope of productivity-enhancing structural change (McMillan and Rodrik (2011).

Considering these reasons, it is time for Indonesia to revive its manufacturing sector as it cannot always rely on its abundant natural resources. Indonesia should put more effort into developing its high-value added and employment-generation sectors such as the manufacturing sector and leave other businesses to go on as usual.

A decade of slow growth which was just 4.5 percent from 2000 to 2010 down from 12.8 percent in the decade prior to the Asian Crisis deserves special attention from both the Indonesian government and the private sector to work together to ensure manufacturing regains its growth and development. Manufacturing is the key sector in creating high-value jobs as well as technology transformation.

This year is actually a good moment for Indonesia to regain its competitiveness in the manufacturing sector. The Indonesian economy is not only a growing market but also an attractive investment destination. This allows firms to operate at economies of scale and thus improve competitiveness.

Indonesia is not only a growing market but also one of the most promising investment destinations in the coming decades. Indonesia has a growing domestic market with an annual income per capita of US$3,000 in 2011 and a rising middle class. This is coupled with the fact that 65 percent of the 237 million population constitute a labor force with unit labor costs lower than that of China and Vietnam, particularly since 2008 and 2011. On top of that, Indonesia has recently attained an investment grade of BBB- from Fitch Ratings.

While there are opportunities, there must be challenges. While we could name from A to Z challenges and things that should be fixed to increase investment in the manufacturing sector and improve manufacturing competitiveness, Indonesia could start the reform with easy and zero-cost steps.

First, simplify business registration. Second, speed up full implementation of electronic tax filing and payment systems. Third, incentivize labor training. Fourth, improve efficiency at the ports including customs and payment systems.

This is the time for Indonesia to articulate a master plan for developing the manufacturing corridor with real action, don’t let Indonesia just be a plan master.●