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Jakarta Post

Domestic capital markets key to closing long-term investment gap

  • Donald P. Kanak


Singapore   /   Thu, November 28, 2019   /   01:08 pm
Domestic capital markets key to closing long-term investment gap Illustration of economic growth (Shutterstock/Number1411)

Indonesia has become the world’s seventh-largest economy on the current Purchasing Power Parity (PPP) basis and one of its primary growth engines, powered by a young and innovative workforce — the world’s fourth-largest — and an inward flows of foreign direct investment.

With President Joko "Jokowi" Widodo’s new administration in place, there is a sense of optimism that Indonesia can fulfill its economic potential and become the world’s fourth-largest economy by 2050. Achieving that milestone depends to a large degree on financing massive long-term investments in physical and social infrastructure, from roads and power to health care and education.

Financing those investments sustainably will require a dramatic expansion of Indonesia’s domestic financial system, especially the sectors that can make long-term investments, such as life insurance, pension funds, mutual funds and capital markets.

As a percentage of gross domestic product (GDP), Indonesia’s long-term investment sectors trail other ASEAN countries, including Vietnam and the Philippines. Closing the long-term financing gap and expanding long-term domestic investment will not only help to fund Indonesia’s growth but will also prepare a pool of domestic savings for the future income and healthcare needs of a rapidly aging population.

International financial institutions can play a role both as investors by providing capital, know-how and technology, as well as working with domestic companies and the public sector, to build the domestic insurance, pension and fund management sectors.

Economic growth is putting enormous pressure on Indonesia’s infrastructure. Demand for electricity is expected to grow by more than 75 percent between 2019 and 2028. From 2015 to 2030, Indonesia will add almost 50 million new urban residents. This means providing transportation, housing, power, water, communications, education and health care to 9,000 new urban residents every day. As such, Indonesia plans to invest almost Rp 6,000 trillion (US$412 billion) between 2020 and 2024 on new infrastructure projects.

One of the lessons from the Asian financial crisis in the late 1990s was it is risky to over-rely on foreign currency financing. To avoid such reliance, Indonesia should expand its domestic long-term savings institutions.

As the figure shows, at only 9 percent of GDP, Indonesia trails several ASEAN neighbors in accumulating long-term financial assets such as insurance, pension and mutual funds. The gap in mobilizing long-term savings is not attributable to lower savings rates nor lower levels of per capita of wealth, for example, Indonesia’s savings rate is comparable to Thailand, with both its savings rate and per capita income higher than Vietnam.

The banking sector plays a key role in financing growth, but modern banking regulations discourage banks from making long-term loans or equity investments because banks receive funding from short-term deposits. Mismatching short-term deposits with long-term loans creates risk for individual banks and the banking system.

In contrast to banks, pension funds and life insurers must accumulate funds for long-term needs, such as education, retirement and aged care. Pension funds, life insurers and mutual funds want to invest in long-term bonds and stocks and are therefore natural providers of long-term capital, and can complement banks, who are the main providers of short- and medium-term financing.

Increasing the size of the domestic pension and insurance sectors can also increase the stability of the financial system. Insurers and pension funds generally make investments in domestic currency and hold those investments to maturity. This provides stable, long-term funding for companies and infrastructure projects, and avoids exposing projects to foreign exchange risk and the economy to capital flight.

It is important that Indonesia identifies fiscally responsible and effective tax and other incentives to expand the long-term investment sectors and the capital markets. Both voluntary and mandatory pension programs in most countries offer certain tax benefits or incentives to encourage participation and enable financial inclusion.

Lessons may also be learned from neighboring ASEAN countries such as Thailand’s Long-Term Equity Funds (LTF) and Retirement Mutual Funds (RMF). Other larger economies in Asia such as Japan, Korea and China have used tax and policy incentives to build large domestic insurance systems.

To enable insurers, pension funds and mutual funds to better meet Indonesia’s infrastructure funding needs, Indonesia’s capital markets need to be larger and provide liquidity in public and private bonds, sukuk, asset-backed securities and stocks of state-owned and private companies.

While Indonesia’s capital markets have grown, they also lag behind several neighboring countries. According to Bloomberg and AsianBondsOnline, Indonesia’s floated book value and bonds outstanding as a percent of GDP, a measure of capital markets size, was only 37 percent in 2018, lower than Vietnam (42 percent) and far behind the Philippines (66 percent) and Thailand (112 percent). With the right policies and cooperation between public and private sectors, Indonesia can close this gap.

In addition to expanding the size of the capital markets, it is important that stock and bond markets innovate ways to finance infrastructure. Indonesia has made some progress in this area — the Financial Services Authority (OJK) issued new regulations in July 2017 for pooled infrastructure funds (DINFRAs), and in January 2019 allowed DINFRA as an investment instrument for both conventional and sharia insurance products. The government is also encouraging retail bond growth and is considering issuing a retail green sukuk in 2020.

DINFRAs are a positive first step in bringing illiquid infrastructure assets to the capital market. Regulatory clarification to ensure domestic long-term institutional asset owners like insurance and pension funds can invest in DINFRAs and encouraging stock exchange listing will be important next steps.

Removing tax disincentives such as investor tax and lender tax for both domestic and nonresident investors will also encourage participation.

With larger capital markets and long-term financial sectors, Indonesia can fund its long-term investment needs and provide better returns to its citizens. Strong, diversified capital markets and investment institutions will encourage Indonesia’s budding digital economy companies to raise capital in Indonesia’s markets instead of heading overseas and allow Indonesia’s citizens to share in their successes.

Increasing domestic investment options may also encourage more domestic assets to repatriate, complementing the government’s efforts at tax amnesty and creating a virtuous cycle of investment. All in all, growing the capital markets and the long-term investment sectors of insurance, pension and mutual funds and the capital markets will help Indonesia realize its potential and face the competitive challenges and opportunities of the next decades.


Chairman of Eastspring Investments, the Asia asset management business of Prudential plc, chairman of the EU-ASEAN Business Council and cochair of the Steering Group of the ASEAN Hub of the Sustainable Development Investment Partnership, an initiative under the World Economic Forum and the OECD.

Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of The Jakarta Post.