GOOD MOMENTUM TO ATTRACT FOREIGN FUNDS TO THE REAL SECTOR- May 2009

INDONESIAN COMMERCIAL NEWSLETTER

May 2007

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GOOD MOMENTUM TO ATTRACT FOREIGN FUNDS TO THE REAL SECTOR

Since Indonesia was jolted by the 1998 monetary crisis, the country's manufacturing industry has been in the doldrums. Productivity decline and capacity utilization has been low partly because the machines have been too old and inefficient.

In the past five years, the capacity of the country's petrochemical industry has scarcely increased. The production capacity for plastic basic materials such as Polyethylene, Polypropylene, PVC resin, etc. has remained unchanged. Similarly, there has been no expansion of the production capacity for upstream steel products. State-owned steel maker PT Krakatau steel has repeatedly announced plans to build upstream steel production facility but none of the plans has come to reality. Meanwhile imports have continued to increase notably in the past three years with growing demand from the downstream sector to follow the revival of the construction and property industries, food and beverage industries.

The root of the problem is finance. Banks still hesitate to offer credits as many of the manufacturing industries are still seen as carrying high risk The government has sought to convince banks and encourage them to offer credits for manufacturing sector such as textile industry. The government provides subsidized loan for the textile industry in a bid to encourage banks to offer credits to the sector. Realization of the program, however, is low as the amount is not adequate to help finance the expensive industry.

Banks more interested in retail banking

Banks, which are expected play their role in financing investment in the manufacturing sector, cited a number of reasons for not immediately providing credits for the real sector. They feel safer to deal with the property sector and provide consumer credits. In the past five years, the portion of investment credits in the total approved credits of commercial banks have declined compared with consumer and working capital credits.

In 2002, investment credits made up 18.8% of the total amount of bank credits. The portion fell to 13.6% in 2006. Meanwhile consumers credit grew from 24.7% in 2002 to 34.7% in 2005. In 2006, the portion fell slightly because of declining purchasing power of the people as a result of the surge in oil fuel prices late 2005.

Working capital credits have almost unchanged in portion from 56% although rising in 2006 with the decline in the portion of consumer credits.

Banks also still are not eager to provide corporate credits. They have not been able to get rid themselves non performing loan nightmare involving many large companies.

Based on the amount of credits provided by banks until lately most banks tend to assume retail banking business. In 2002, credits disbursed to the corporate sector made up 47.1% and those to individual borrowers made up 46.9%. In 2006, retail sector dominated credits accounting for 54.9% as against only 41.1% for private companies.

The change in orientation to retail banking makes it difficult for the manufacturing sector to raise funds for investment in large amount. Most credits extended by banks to the manufacturing sector are in working capital credits, with working contract or sales contract as collateral to reduce possibility of defaults.

New projects also find it difficult to secure bank loan as most banks are more interested in old clients which still have shown good performance. New investment projects could not easily secure banks loans. If any the interest is too high making the project financially not feasible.

Foreign funds flood into Indonesia

Ironically, banks currently have excess liquidity and meanwhile, foreign funds continue to flow in help push up the composite share price index (IHSG) to cross the 2000 point level.

According to Bank Indonesia, in January-May, 2007, foreign funds flowing in to the country totaling US$ 8.5 billion including US$ 3.96 billion placed in Bank Indonesia promissory notes (SBI), US$ 3.2 billion placed in state bonds, and US$ 1.3 billion invested in shares.

Altogether foreign funds at present totaled US$ 6 billion in SBI and US$ 9.4 billion in state bonds and US$ 62 billion in stock exchange.

The impact of the inflows of foreign funds is shown in the decline in the Bank Indonesia benchmark interest rate (BI rate) now at 8.5% after gradually cut from 12.75% early 2006. Meanwhile, the amount of foreign exchange reserve has reached a leak record at US$ 53 billion helping strengthen the rupiah to hit the level of 8,812 per U.S. dollar late May, 2007. The. IHSG also rose since January, 2007 and in May IHSG reached the level of 2093 points from 1,800 three months earlier.

However, the improvement of the macro economic indicators as if has nothing to do with the real sector. Funds collected by Bank Indonesia could not be used to finance investment projects Foreign funds could be attracted to finance the real sector through Initial Public Offering in capital market or through bond issues.

Door for foreign capital to the real sector

Now is the right time to attract foreign funds through capital market with the limited listed companies in the stock market. The more stocks being traded the greater the possibility of stock market to expand. The rising IHSG, however, carries a risk a crash if foreign funds take a reversal in flows.

Many manufacturing companies need large fund to replace their old machines and to expand capacity, but they are in no position financially to modernize their factories. Therefore, they will not sell well in stock market.

A long times needed to prepare IPO in the manufacturing sector that the good momentum at present could be utilized immediately.

Another way of drawing foreign funds into the country is through state bonds. The government may use bond funds to finance development such as infrastructure projects or manufacturing projects.

All attempts to revive the real sector seem to have failed because cheap funds are not easily available. Foreign investors show strong interest in venturing in portfolio investment but they tend to stay away from the real sector. The government, therefore, needs to play a role to bridge the gap by creating financial instrument that could attract funds to be used to finance the real sector.

The government also needs to be more transparent in the management of funds raised through bond issues. One of the advantages of bond issues is the government has full control in utilizing the fund unlike funds provided by donor countries through bilateral or multilateral agreements. The government is not entirely free to use fund from donor consortium. There are certain terms to be met.

Bond funds are certainly not enough to finance development of the real sector, but good and efficient management would encourage the growth of the real sector. Healthy growth of the real sector will finally attract foreign investors to start direct investment in the country.

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