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Jakarta Post

Analysis: Deepening RI financial markets: Managing issuers, creating investors

Everybody knows that stability in financial markets is a must for Indonesia

Andrian Bagus Santoso (The Jakarta Post)
Jakarta
Wed, June 24, 2015

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Analysis: Deepening RI financial markets: Managing issuers, creating investors

Everybody knows that stability in financial markets is a must for Indonesia. The Indonesian financial market is considered shallow compared with its peers. Indonesia'€™s stock market capitalization to GDP ratio is 50 percent, which is very low in comparison with Malaysia (141 percent), Thailand (111 percent) and the Philippines (92 percent). Indonesia'€™s interbank lending to GDP ratio also shows how shallow our financial market is compared with our peers. Indonesia only scores 4 percent, compared with Malaysia (82 percent), Thailand (16 percent) and the Philippines (15 percent).

Similar with equity and money markets, Indonesia'€™s bond market also lags behind its peers. Both Indonesia'€™s government bond market to GDP ratio and corporate bond to GDP ratio score lowest with 12 percent and 2 percent respectively compared with Malaysia (59 percent and 42 percent), Thailand (55 percent and 18 percent), Philippines (30 percent and 6 percent). Shallow financial markets possess a high risk of volatility at the event of sudden capital reversal.

Bureaucracy suppresses supply

All key players face several obstacles in deepening Indonesia'€™s financial markets. Both supply and demand sides face a similar problem which is the limited number of issuers as well as a low investor base. Lack of product diversification in the market also plays significant role creating an illiquid financial market. These conditions are exacerbated by low infrastructure and policy support from the government. This article will only focus on the supply and demand side of the financial market.

As of 2014, Indonesia has only 507 listed companies in its equity market. It has been growing slowly in the last decade, averaging 5.4 percent a year. This number of listed companies in the equity market is relatively low compared to peers like Malaysia (816) and Thailand (543). The main reason for this is a lengthy issuance time that takes four to six weeks compared with an average of two weeks in neighboring countries.

Another cause is the perception of a higher tax burden as a result of greater disclosure and higher listing costs. The bond market is also facing similar challenges of a limited and slow-growth issuer base. The Indonesian bond market is dominated by government bonds, which contribute up to 54 percent of total bonds outstanding. Indonesia'€™s government bond market is relatively more developed than the corporate bond market. The share of corporate bonds remains weak due to the lengthy issuance process for corporate bonds which takes four to six months. This lengthy process also plays a significant role in increasing costs for the company. Reluctance to list bonds by big companies causes Indonesia to lack a high volume of credible bond issuances.

Unfavorable conditions for investors

Indonesia also faces similar problems on the demand side. The Indonesian equity market'€™s retail investors in May 2015 only amounted to 488 thousand or only 0.2 percent of the total population. This number is low compared to Malaysia and Singapore with 12.8 percent and 30 percent of their total population respectively. In the bond market, there is one important thing that Indonesia lacks: the absence of market-makers especially in the corporate bond market.

Institutional investors like pension funds or asset managements are often forced to buy and hold bonds until their due date because there are no market activities available for different products, especially for corporate bonds. The situation is worsened because retail investors rarely buy corporate bonds due to high ticket size, which amounts to a minimum of Rp 1 billion per transaction. Investors also face several regulations that limit the ability of foreigners to directly invest in Indonesia'€™s capital market.

Learning from peers'€™ success stories

In order to improve the issuers'€™ base, Indonesia must simplify its issuance regulations, especially in the bond market. As mentioned above, normally it takes up to six months to issue a bond in Indonesia. In Malaysia and Thailand this process takes only two weeks and slightly more in Singapore at three weeks. International markets tend to gradually reduce approval times for all classes of debt issuers, mostly as part of a concerted attempt to streamline the issuance process. Thailand gradually reduced its maximum approval time in 2001, 2006 and 2009 to its current level.

In order to increase the number of retail investors, Indonesia could design some sort of incentive. One successful experience can be seen in India. India provides retail investors with tax incentives for making capital market investments through several programs such as Rajiv Gandhi Equity Saving Scheme (RGESS), Section 80CCC, Public Provident Fund (PPF) and Section 80CCD. The tax incentives vary depending on the investment made. The incentive is given in the form of a tax deduction for the following year with a maximum of three years as long as they keep their investments.

Indonesia'€™s population of 250 million signifies huge potential for retail investors. They might not be big capital investors, but they constitute a sizable amount in the number of investors. The transaction volume will make the market more active and their capital will surely help maintain the market in a liquid condition.

In order to improve domestic institutional investor participation, Indonesia should shift its investment behavior. Up to 29 percent of institutional investors'€™ funds are invested in cash and money market instruments, which are considered short term instruments. This trend is significantly higher compared to developed markets such as the UK (0 percent), Germany (1 percent) and Brazil (4 percent).

Currently, institutional investors, especially pension funds, measure their performance annually using short term benchmarks. Another factor is that there are no penalties for investors to withdraw their money before retirement time. Shifting the mindset of the pension industry would promote development of long-term funding in Indonesia and help stabilize the financial market.

The challenges in Indonesia'€™s financial markets do not reside only on the supply and demand side. Indonesia still has much homework to do in order to improve other aspects, such as product gaps, infrastructure gaps and a cumbersome regulatory climate. Sound financial markets will enhance resilience and the capacity to cope with shocks, improve the effectiveness of macroeconomic policy, as well as support solid and inclusive growth.
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The writer is a researcher at Mandiri Institut.

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