As one of the strongest emerging economies in the world, the country'€™s lucrative growth rate has been attracting foreign and domestic investors at the institutional and individual level. However, assessing its financial products, services and infrastructure available to investors, the country'€™s current state of financial expansion is considered very low compared to its ASEAN peers. Market penetration is also still lower than it should be. Hence, there is much progress needed across financial infrastructure as financial expansion also plays a very important role in financial resilience.

It is compulsory for the country to expand its financial market to grow. However, the country is facing a significant infrastructure investment gap of over US$468 billion, based on the Master Plan for the Acceleration and Expansion of Indonesian Economic Development (MP3EI 2011-2025). The banking industry, as the most dominant funding source, is unable to ramp up its lending. Loan to deposit (LDR) constraints, inadequate funding to small and medium enterprises (SMEs) amid crowding out to large corporations and the need to provide above-inflation returns to retirement savings to prevent the middle income trap, are all part of the problem. To do a full reform in its capital market, the country will need to increase its financial market by seven times the current size within 16 years. It also needs a sustainable growth rate of at least 10 percent higher than that which it achieved in the past five years.

Looking at the ecosystem, the country'€™s financial market is mainly built by six components. The capital users are the entities that need funding, such as private and public companies that aim to see growth in their scales, governments and agencies that need to boost economic growth, and individuals who need financial independence. Their needs shall be covered by capital providers, which include financial and institutional investors (for example: pension funds, insurance companies and private equities), government, agencies and individual investors.

The mechanism of fund trading is being done through financial intermediaries, such as banks, brokers, insurers and asset or wealth managers, using several types of financial instruments, consisting of debt, equity, foreign currencies and the money market. These transactions are being executed using market infrastructure, such as exchanges, depositories, custodians, rating agencies or data providers and monitored by regulatory, legal and macro environments.

However, over the years, capital market growth has tended to be stagnant and lagging in most components. While the ratio of foreign to local ownership in bonds and stocks, credit bureau coverage, level of inflation and timing for securities issuance process have increased, it still has yet to be optimized. Indonesia is also lagging from its emerging market peers in terms of financial market depth. Stock market capitalization to gross domestic product (GDP) has not moved much for a decade, while the size is only half of Thailand or a quarter size of Malaysia. Similar comparisons can be seen in the government bond market to GDP, while its corporate bond market is less than 1 percent of GDP.

Looking at the number debt and equity capital market, Indonesia is still low and has not been growing over the past five years. The corporate sector still relies heavily on bank funding at around 56 percent, considered higher than its Southeast Asian peers, which average 24 percent. The country'€™s bond and equity issuance is at 29 percent and 13 percent, respectively, while the issuance in each Singapore, Malaysia, Thailand and the Philippines is above 50 percent for bonds and 15 percent for equity. Moreover, Indonesia has high foreign participation, which also imposes external risk factors, should the investors decide to pull out from the market (for example: seeks better investment options, quantitative easing (QE) by the US Federal Reserve or change in sociopolitical and economic stability). The situation is hampered by a low number of issuers and limited participation across retail and institutional investors in the debt and equity capital market.

In the bond market, domestic investors tend to have a '€œbuy and hold mentality'€. This is reflected by a low bond turnover ratio due to the absence of market makers and high ticket size of corporate bonds, in comparison to sovereign bonds. This causes a significantly higher gap of bid-ask spread and thin secondary market, as investors see that the easiest way to invest is through the initial public offering (IPO) listing. Liquidity of government bonds in Indonesia is also low compared to its peers, given that corporate bonds are significantly less liquid compared to those of the government, as their issuance and size are both very low in terms of percentage to GDP. The low liquidity of corporate bond is driven by limited supply of quality issues and low retail participation.

The country'€™s foreign exchange (forex) reserve is also the smallest in Southeast Asia, relative to its economic output. In 2014, forex reserves stood lower than 15 percent of GDP, compared to Vietnam and the Philippines (more than 20 percent), as well as Thailand, Malaysia and China (more than 35 percent).

The country'€™s forex market also has low derivative volume and non-existing long tenure products, which makes it harder for shareholders to place long-term investments. It is also driven by a combination of a current-account deficit and periodical interventions by the central bank to defend the currency.

Note that Indonesia'€™s imports started to surpass its export level in 2012, while its current-account deficit in 2014 reached $30 billion, creating higher urgency for the central bank to manage the rupiah. Moreover, the forex market is inaccessible to non-bank participants and lacks a credible rupiah floating rate benchmark. These situations have created a challenging situation if the central bank needs to intervene and/or defend the rupiah.

By identifying these gaps across financial instruments, we have reviewed some of the oversights in the capital market that need to be focused on. On Sept. 7, Mandiri Institute and Oliver Wyman will hold a public conference series on financial expansion, aiming to gather all stakeholders in the capital market and find executable, quick-win steps that can be done in shorter periods, to catch up with the country'€™s emerging market peers.

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The writer is a senior manager at Mandiri Institute.