Posted on 13 May 2015
Indonesia has the potential to become the seventh largest economy in the world by 2030 with an average economic growth of 5.3 percent and a gross domestic product (GDP) of US$4 trillion (the country’s current GDP is around $900 billion).
For the next five years, the
government has set a very ambitious economic growth target of 7 percent
annually with GDP per capita in 2019 at Rp 72 million ($5,450), an increase of
more than one half of the GDP per capita in 2014.
This high growth target brings consequences for the high funding need for
development. The government’s medium-term development plan (RPJM 2015–2019)
predicts that to achieve this target, around Rp 22.5 quadrillion in funding is
needed with the contribution from the government around 15 percent.
About 25 percent (Rp 5.5
quadrillion) is needed, for infrastructure development, which includes road,
rail, land, air and sea transportation; urban development; power; energy;
information technology; water resources; sanitation and housing.
For infrastructure funding, the government expects that the private sector will
contribute around 31 percent while the rest will be provided by central and
local governments as well as state-owned enterprises.
To achieve this ambitious target and to become the seventh largest economy in
2030, there is a need to significantly deepen the financial sector in Indonesia.
The capital market needs to grow around six to eight fold to achieve a $4-6
trillion market value in 2030, which implies that the capital market must grow
around 13 to 16 percent annually for the next 16 years. If the government fails
to seriously deepen the financial sector, the potential loss is around $600
billion.
Compared to other countries in the same group, the financial sector in
Indonesia is very shallow. Several indicators to measure financial deepening
such as the ratio of capital market to GDP, the ratio of outstanding government
bonds to GDP, interbank loans to GDP and daily transaction volumes in the US
dollar for exports and imports for Indonesia are low. In addition, a ratio of
M2 (money supply) to GDP in 2014 for Indonesia was only 41 percent, far below
Malaysia (143 percent), Singapore (133 percent), Thailand (134 percent) and the
Philippines (70 percent).
Funding needed from the private sector comes from banking, the capital market,
the bonds market, internal private sources (own capital, retained earnings and
depreciation) and foreign capital. Other than internal private sources, until
now banking has contributed the largest portion of investment funding.
However, banking’s capacity for funding is now limited because the loan to deposit
ratio (LDR) has reached 90 percent, although the ratio of loan to GDP is still
40 percent. Therefore, other funding sources need to be developed to fulfil the
7 percent growth target.
Other funding sources are portfolio investment and foreign direct investment.
Capital inflow in the first two months of 2015 is relatively high compared to
the same period last year. However, since the second week of March, the inflows
have slowed and even now are already outflowing. In addition, the foreign
ownership of outstanding government bonds is relatively high and has reached 40
percent. This condition makes the financial sector in Indonesia vulnerable from
sudden capital outflows.
There are six components that build an ecosystem for financial deepening: capital
users (those who need capital), capital providers (those who own capital),
financial intermediaries, financial instruments, market infrastructure and
regulatory, legal and macroeconomic conditions. Comparing Indonesia’s condition
in these six components with other countries such as Malaysia, Thailand, India,
the Philippines, Chile and South Africa, one can conclude that Indonesia is
lagging in almost all components.
It mainly lags on issues in the capital market, weak domestic investors because
of a lack of support from strong financial intermediaries, limitations in a
variety of instruments, and policies that do not provide a sufficient incentive
for financial sector development. These issues indicate that Indonesia’s
financial sector is still shallow and needs fundamental improvements.
Capital and bonds markets in
Indonesia need to be developed. Indonesia does not have liquidity in some
products like other countries do, like for foreign exchange options,
asset-backed securities, real estate investment trusts and exchange traded
funds. These products offer additional options for investors as well as provide
hedging while deepening financial markets in Indonesia.
The Financial Services Authority (OJK) is preparing the issuance of these
products and it is expected that by the end of this year these products can be
utilized by investors.
