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The imperative to develop Indonesia’s financial sector
One key feature of a deep financial sector is the availability of long-term investment capital. To achieve this, participation in pension and insurance programs should be increased; at the same time, early withdrawals should be discouraged.
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A visitor browses information on investment potential in West Java on Sept. 19, 2024, at the West Java Investment Summit 2024 in Bandung. Now in its sixth edition, the summit provides a platform for West Java to promote investment opportunities and potential in the province. (Antara/Raisan Al Farisi)
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ndonesia’s journey to high-income status hinges on developing a robust financial sector. However, the current state of the financial industry is a cause for concern. It is shallow, inefficient and plagued by governance issues, which is a stark contrast to the deep, efficient and well-functioning financial sectors of developed economies.
One key feature of a deep financial sector is the availability of long-term investment capital. To achieve this, participation in pension and insurance programs should be increased; at the same time, early withdrawals should be discouraged.
Some progress in enlarging pension and insurance participation has been seen recently. However, more public dissemination will be needed to overcome resistance.
Regarding efficiency, one key obstacle is the prevalence of high lending rates. This comes from high real interest rates (lending rate minus inflation rate) and wide banking margins (the difference between deposit and lending rates).
It is well known that banking margins in Indonesia are among the highest in the world. The upshot is inefficiencies and low competitiveness across the economy. Despite Indonesia’s recent low inflation, why are real interest rates still very high? The answer lies in the mandate of Bank Indonesia (BI) to stabilize the rupiah.
With a high global interest environment, the central bank must keep real interest high to stabilize the currency. What can alleviate the central bank’s burden? One key element is the repatriation of export proceeds. Doing so will increase foreign reserves, which has two effects: First, it will strengthen the rupiah; second, it will provide BI with ample ammunition to smooth any currency fluctuations.
To shrink banking margins, it is crucial to foster more competition in the banking sector. Despite the presence of over 100 commercial banks, Indonesia’s current banking landscape may not be conducive to healthy competition.
