The important question to ask at the moment is whether Indonesia is in a state of crisis. Fundamentally, the Indonesian economy is much stronger and more sound than when Indonesia suffered through the Asian economic crisis in 1998.
However, this fundamental comparison is of little use because the source of the current problem is not in the fundamentals but in the crises of liquidity and confidence.
I like to use the analogy of a strong ship in a small river that is part of a bigger network of rivers. When the water level falls, the journey will be problematic no matter how strong the ship is. That is exactly the situation that Indonesia is facing now.
As a relatively small stock market with limited liquidity, the Indonesian market was easily influenced by the bigger interrelated stock markets around the globe and prone to the liquidity rush. A concentration of trading volume on Bakrie's related companies, which were heavily geared and heavily speculated upon, triggered the whole market meltdown last week.
Although Indonesia's economic fundamentals are stronger now than at the beginning of the Asian crisis, this does not mean Indonesia will be insulated from the global liquidity crunch. There are three problems that underlie the current capital market meltdown.
The first and the most serious problem is the top decision makers' state of denial -- they are arguing that Indonesia is not in a state of crisis. This attitude obviously rattled market confidence. How is the government expected to take a proactive approach to solve the problem when everyone is still denying there even is a problem?
We claim we are not in crisis even though our stock market has dropped by almost 50 percent. We claim we are not in crisis even though neither investors nor issuers believe anymore in the capital market function. We claim we are not in crisis even though everyone is tightening up and running for cover by reconsidering their investments and capital expenditure. How very ironic.
This all reminds me of the government's attitude during the early stages of the financial crisis in 1997. The financial sector and real sector are closely related and the failure in the financial market will sooner or later pass through to the real sector.
Second, we are facing a dysfunctional capital market system. The capital market is supposed to be an efficient delivery mechanism for fund mobilization and allocation as well as for price discovery of assets and risks. When the share price no longer reflects the fair price of assets because of irrational behavior, the capital market can be called dysfunctional.
A dysfunctional capital market is a serious problem for a financial system because it is crucial for supporting economic growth. When it is much better to buy shares in plantation companies or to buy financial assets than to do the planting or increase the machine capacities, there will be no capital expenditure made. Economic growth cannot be expected.
Third, there is a too-big-to-fail syndrome in the capital market. We have to learn the hard way that the disproportionate concentration of wealth and leverage in certain counters in the Indonesia Stock Exchange is not healthy. We can also say that market discipline has failed to enforce prudent monitoring and failed to rule out excessive funds being concentrated in a few counters.
Indonesia suffered a too-big-to-fail syndrome in the market as the recent liquidity problem faced by the Bakrie Group of Companies led to the rush for the exit from other stocks on the Indonesia Stock Exchange.
Obviously the threat of the too-big-to-fail syndrome in the corporate sector directly affected investor confidence in the market. The capital market is an integral part of the financial system. It should provide efficient delivery mechanisms for savings mobilization and allocation, risk and liquidity management and corporate governance.
For sure we cannot ignore the improvement in areas of prudential supervision, the accounting and disclosure requirements, legal and judicial systems, proper sequencing of financial liberalization, good monetary policy and price stability, as well as healthy reserves and a strong banking system. However, these things are not enough to prevent a capital market meltdown when global liquidity dries up.
To prevent a further crisis we have to rectify the dysfunctional capital market and prevent the too-big-to-fail syndrome in the corporate sector. More importantly, we need to admit that we are facing a serious situation that requires a proactive solution.
I strongly believe that the overhang in the Bakrie Group due to margin trading pressure will find its own solution. Unfortunately, I also believe that the global uncertainty will stay with us for a long time. Indonesia needs to adopt a comprehensive, proactive program to address the issue of the too-big-to-fail syndrome and create a proper mechanism of market surveillance to keep the capital market functioning properly. In the current situation, regulatory intervention to ensure the market continues to function properly is crucial -- the regulator needs to stay ahead of the market and reacting alone is not adequate.
Lin Che Wei is founder of Independent Research & Advisory Indonesia. He can be reached at lin_chewei@pacific.net.sg
