A.
Report and Recommendation of the President to the Board of Directors
Project Number: 32507-02 October 2009
Proposed Loan for Subprogram 2 Republic of Indonesia: Capital Market Development Program Cluster
CURRENCY EQUIVALENTS (as of 28 September 2009)
Currency Unit – rupiah (Rp) Rp1.00 = $0.000103 $1.00 = Rp9,655
ABBREVIATIONS
ADB – Asian Development Bank APRA – Australian Prudential Regulatory Authority ASIC – Australian Securities and Investments Commission AusAID – Australian Agency for International Development BI – Bank Indonesia BPA – bond pricing agency CMDP – capital market development plan CMDPC – Capital Market Development Program Cluster CMMP – capital market master plan CSP – country strategy and program DGFI – Directorate General of Financial Institutions DMO – Debt Management Office DOT – Directorate of Taxes DPSP – Development Policy Support Program EET – exempt-exempt-taxable EU – European Union FATF – Financial Action Task Force FDI – foreign direct investment FGRSDP – Financial Governance Reforms Sector Development Program FGSSR – Financial Governance and Social Security Reform Program FSDPF – Financial Sector Development Partnership Fund FSPP – financial sector policy package GDP – gross domestic product GFMRAP – Government Financial Management and Revenue Administration Project GMRA – Global Master Repurchase Agreement IAA – Indonesian Accounting Association IAIS – International Association of Insurance Supervisors IDX – Indonesia Stock Exchange IMF – International Monetary Fund IOSCO – International Organization of Securities Commissions IPO – initial public offering JICA – Japan International Cooperation Agency JSF – Japan Special Fund JSX – Jakarta Stock Exchange KPEI – PT Kliring Penjaminan Efek Indonesia (Indonesian Clearing and Guarantee Corporation) KSEI – Kustodian Sentral Efek Indonesia (Indonesian Central Securities Depository) LIBOR – London interbank offered rate LPS – Lembaga Penjamin Simpanan (Deposit Insurance Institution)
MOF – Ministry of Finance MOU – memorandum of understanding NPL – nonperforming loan OECD – Organisation for Economic Co−operation and Development OJK – Otoritas Jasa Keuangan (Consolidated Supervisory Authority for Financial Services) OTC – over-the-counter PAI – Project Administration Instructions PRC – People’s Republic of China PT SMF – PT Sarana Multigriya Finansial (Secondary Mortgage Corporation) SEC – Securities and Exchange Commission SMEs – small and medium-sized enterprises SOE – state-owned enterprise SRO – self-regulatory organization SSX – Surabaya Stock Exchange TA – technical assistance TAMF – technical assistance management facility UNODC – United Nations Office on Drugs and Crime USAID – United States Agency for International Development
NOTE
In this report, "$" refers to US dollars unless otherwise indicated.
Vice-President C. Lawrence Greenwood, Jr., Operations 2 Director General A. Thapan, Southeast Asia Department (SERD) Country Director J. Nugent, Indonesia Resident Mission, SERD Director J. Ahmed, Financial Sector, Public Management and Trade Division, SERD
Team leader V.V. Subramanian, Principal Financial Sector Specialist (Capital Markets), SERD Team members E. Ginting, Economist (Trade and Financial Sector), SERD T. Hla, Economist (Financial Sector), SERD T. Niazi, Senior Public Sector Management Specialist, SERD H. Omar, Senior Financial Sector Specialist, SERD R. O’Sullivan, Senior Counsel, Office of the General Counsel L. Abenojar, Administrative Assistant, SERD
In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.
CONTENTS
Page LOAN AND PROGRAM SUMMARY i I. THE PROPOSAL 1 II. BACKGROUND 1 III. MACROECONOMIC CONTEXT 1 IV. THE SECTOR 8 A. Sector Description and Performance 8 B. Issues and Opportunities 14 C. Lessons 20 V. THE PROPOSED PROGRAM 21 A. Program Design 22 B. Impact and Outcome 22 C. Policy Framework and Actions 22 D. Important Features 26 E. Financing Plan 27 F. Implementation Arrangements 28
VI. TECHNICAL ASSISTANCE 30 VII. PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS 31 A. Benefits 31 B. Social and Environmental Safeguards 31 C. Risks 31 VIII. ASSURANCES 33 IX. RECOMMENDATION 33
APPENDIXES 1. Design and Monitoring Framework 34 2. Sector Analysis 40 3. Development Coordination Matrix 47 4. Policy Matrix and Development Policy Letter 49 5. List of Ineligible Items 67 6. Summary Poverty Reduction and Social Strategy 68 7. Environmental Assessment of the Policy Matrix 71
LOAN AND PROGRAM SUMMARY
Borrower Republic of Indonesia
The Proposal The current proposal comprises a loan of $300 million for subprogram 2 of the Capital Market Development Program Cluster (CMDPC).
Classification Targeting classification: General intervention Sector (subsector): Finance (financial sector development) Themes (subtheme): Economic growth (economic efficiency), governance (economic and financial governance) Location impact: National (high impact)
Environment Category C Assessment
The Program Financial sector reforms are crucial to raising Indonesia’s growth Rationale rate and enhancing the economy’s resilience. Since 1997, the country has successfully undertaken key financial reforms, restoring the solvency and profitability of the banking sector. However, the financial sector is shallow and dominated by banks. While the banking sector has been strengthened, regulators accept that capital markets also need to be reformed and cross- border links must be established to develop greater resilience to external shocks. Although Indonesia's nonbank financial sector, particularly the capital markets, is still small, it offers a major opportunity to rebalance the financial sector and to reinvigorate growth through more efficient intermediation.
Indonesia has adopted the appropriate macroeconomic policies to arrest the impact of the global financial crisis and maintain steady growth. The International Monetary Fund has lauded the country's macroeconomic responses. However, the current crisis also highlights the longer-term challenges of improving the structural resilience of Indonesia's financial sector by expanding and enhancing the regulation and governance of the capital markets. Confidence that credit and financial markets will continue to function properly will be crucial for economic activity to continue to increase. Short-term measures to boost liquidity and ward off pressure on balance sheets will need to be complemented by medium-term efforts to improve financial supervision further through better governance of market institutions to safeguard financial systems.
Enhanced domestic capital markets can be an efficient source of finance for the Government and Indonesian corporations while providing a safe and stable environment for investors. Infrastructure development will also need a deep and vibrant domestic capital market to ensure that refinancing risks (refinancing existing debts) are reduced.
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The CMDPC was formulated as two single-tranche subprograms anchored on the Government's medium-term reform agenda and its financial sector reform programs from January 2006 to December 2010. This required steps to foster deeper and more liquid domestic capital markets, including (i) broadening the investor base; (ii) encouraging the development of more diverse local financial products; (iii) improving legal, regulatory, and institutional frameworks; (iv) upgrading governance and transparency; and (v) establishing more sound market infrastructure and institutions. ADB approved a single-tranche loan of $300 million under subprogram 1 (2006–2007) of the cluster in December 2007. Subprogram 2 covering the period October 2007–August 2009 has built on continued reforms in line with the Government’s medium-term reform agenda and its capital market master plan, 2005–2009 (CMMP) and will provide a base for the CMMP, 2010–2014, which is being developed with ADB TA and will be implemented with the support of a proposed TA that is being separately processed. Subprogram 2 has also taken into account achievements under subprogram 1.
Subprogram 2 is an important part of the CMDPC, which aims to strengthen transparency and information disclosure in the capital markets. This is essential to building confidence in those markets and their institutions, expanding regulatory oversight, and ensuring enhanced price discovery and market liquidity for market participants.
The reform agenda is structured around the following policy outcomes, which form the basis of the CMPDC's four components: (i) enhancing information disclosure and price discovery, (ii) promoting deeper and more liquid financial markets, (iii) improving market surveillance and investor protection, and (iv) strengthening governance and human resource capacity.
Post-program monitoring framework. The Government recognizes that the reform program would need to extend over the medium term beyond the two subprograms under the CMDPC. As such, a post-program monitoring framework for follow-up policy actions covering September 2009–June 2011 has been developed in consultation with various agencies. This will eventually be used as the basis for a follow-up program, currently in the 2011–2012 country pipeline. The post-program monitoring framework is proposed to be supported by a TA that is being separately processed in parallel with support from other development partners, such as the Japan International Cooperation Agency and the Australian Agency for International Development.
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Impact and Outcome The impact of subprogram 2 as part of the overall impact of CMDPC will be greater financial sector diversification and resilience. The outcome of the Program is greater contribution by the capital market to domestic financing. Towards this end, CMDPC supports accelerated capital market growth to enable more diversification of markets combined with stronger regulatory and supervisory capacity to ensure resilience of the financial sector that will protect the economic development of the economy. The Program is expected to lead to an increase in the nonbank financial sector’s share of total financial assets.
The Program Loan A loan of $300 million from ADB’s ordinary capital resources will Financing Plan be provided under ADB’s London interbank offered rate (LIBOR)- based lending facility for subprogram 2. The loan will have a 15-year term, including a grace period of 3 years; an interest rate determined in accordance with ADB’s LIBOR-based lending facility; a commitment charge of 0.15% per year; and such other terms and conditions set forth in the draft Loan Agreement.
Period and Tranching The implementation of subprogram 2 covered the period from October 2007 to August 2009 with a single tranche loan of $300 million. The Government has completed all actions in the policy matrix for subprogram 2.
Counterpart Funds The Government will use the local currency counterpart funds generated by the loan proceeds to meet program expenditures and associated costs of reform and additional budgetary allocation for the fiscal stimulus program that is addressing the international credit crisis.
Executing Agency Bapepam-LK
Implementation Bapepam-LK has been the Executing Agency for subprogram 2 Arrangements and has monitored and facilitated the implementation of the agreed upon reform actions to ensure that they have been carried out in a timely manner. The implementing agencies have been Bank Indonesia; Bapepam-LK, Debt Management Office (DMO), the Directorate of Taxes (DOT), all three under the Ministry of Finance and the Indonesian Stock Exchange (IDX). Bapepam-LK established a program coordination committee chaired by the Bapepam-LK with representatives from Bank Indonesia, Bappenas (National Development Planning Agency), DMO, DOT and IDX. The committee has been responsible for coordinating the implementation program actions and sustaining them. The committee has overseen the implementation of the policy actions detailed in the policy letter and the policy matrix, and has provided guidance and direction to Bapepam-LK, the implementing agencies, and other line agencies of the Borrower.
Procurement The loan proceeds will be used to finance the full foreign
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exchange costs (excluding local duties and taxes) of items produced and procured in ADB member countries (other than items specified on the list of ineligible items and imports financed by other bilateral and multilateral sources). The Government will certify its compliance with this formula with each withdrawal request. Otherwise, import documentation under existing procedures will be required. ADB reserves the right to audit the use of the loan proceeds and to verify the accuracy of the Government’s certification.
Program Benefits and The CMDPC has provided a policy framework that encourages Beneficiaries financial innovation such as new instruments and longer tenors critical for infrastructure funding, and new kinds of intermediation. It will enhance information disclosure and facilitate price discovery, thus improving the efficiency with which financial markets price risk. This will help to create deeper and more liquid capital markets. At the same time, subprogram 2 will promote stronger intermediaries that are better able to mobilize and allocate resources and risks. Better market surveillance and investor protection will promote stability and resilience, and are essential for capital market development. To maintain the momentum of reforms, the Government proposes to have in place the CMMP, 2010–2014, which is being developed with ADB TA and will be implemented with the support of a proposed TA that is being separately processed. Together with broader economic reforms in Indonesia, the reform of capital markets will contribute to financial sector stability and more broadly to productivity growth and employment generation. Risks and Assumptions The assumptions underlying subprogram 2 included the following: (i) The economy will withstand the direct adverse effects of the ongoing global financial crisis, both the decline in economic activity and the distortions created in Indonesian financial markets. (ii)The needed political will and commitment to pursue capital market reforms will continue.
While mitigation measures have been put in place for some of the key risks anticipated, subprogram 2 did face some risks.
Implications of the global financial crisis and external vulnerabilities. The main risk from the global financial crisis has been the possibility of capital outflows that could have affected the financial sector. During 2005–2007 Indonesian macroeconomic indicators have improved significantly, which translates into more resilience to external shocks. However, Indonesians residents can switch to foreign assets easily, and there are significant foreign holdings, especially in the stock market and government bonds. Thus, Indonesia has been vulnerable to sudden shifts in investor sentiments. The Government will also have larger gross financing needs over the next two years, and the availability and cost of this gross financing poses risks. Stronger macroeconomic
v performance, a high degree of policy continuity, better fiscal performance, and improved liquidity in the global financial markets have mitigated these risks.
Fiduciary and reputational risks. Civil society groups have also raised concerns about the proper use of development partner funds. Despite considerable improvements in the fiduciary environment in Indonesia since 2000–2001, risks had remained. Indonesia has a public sector institutional reform agenda aiming to address concerns over the quality of its public financial management procedures and processes. The World Bank’s Government Financial Management and Revenue Administration Project and other development partner programs are helping the Government to lock in and implement institutional reforms in public financial management.
Sustaining reforms. The financial and operational autonomy of Bapepam-LK, which is essential for its effective supervision of the nonbank financial sector, will need an appropriate regulatory framework. Vested or competing interests might have opposed reforms being undertaken by the Government. The consolidation of reform initiatives in recent years, and the commitment by the Government to continue with reforms has ensured Indonesia is on the path to renewed rapid growth and accelerated poverty reduction.
Governance and capacity constraints. Unless institutional and human capacity development had been fostered within Bapepam- LK, the implementation of reforms might have been delayed. TA will help address Bapepam-LK’s capacity weaknesses. In addition, the Government has agreed to commit, through its normal budgetary processes, expanded provisions for human development to sustain capacity building efforts over the medium and long term. ADB has provided support for anticorruption measures, including procurement reforms, during the past 7 years, and a number of ongoing activities funded by ADB have an anticorruption and capacity building focus. ADB has also supported the Partnership for Governance Reform—a cooperative relationship between the Government, civil society, the private sector, and international development partners on governance reform.
Enforcement constraints. Bapepam-LK continued to have difficulty implementing its compliance and enforcement mandate effectively. The Program has helped to strengthen its investigation strategies and enforcement skills through clearly defined capacity building programs within Bapepam-LK.
I. THE PROPOSAL
1. I submit for your approval the following report and recommendation on a proposed loan to the Republic of Indonesia for subprogram 2 of the Capital Market Development Program Cluster (CMDPC).1 The program design and monitoring framework is in Appendix 1.
II. BACKGROUND
2. The CMDPC was formulated as two single-tranche subprograms anchored on the Government’s Financial Sector Reform Program. The CMDPC period was envisaged from January 2006 to December 2010. In December 2007, the Asian Development Bank (ADB) approved a single-tranche loan of $300 million for subprogram 1 (2006–2007).2 Subprogram 2 covered October 2007 to August 2009. In developing subprogram 2, the medium-term reform agenda under subprogram 1 and its timing were to be reviewed in light of the accomplishments under subprogram 1 and possible changes in the policy environment including the international credit crisis, modified as appropriate, and supported by the single-tranche subprogram 2. This was expected to provide flexibility in program design. The reform agenda under subprogram 2 has built on reforms to enhance financial system resilience and has been in line with the Government’s financial sector reform agenda. The Government has strongly supported the processing of subprogram 2 as originally envisaged to sustain the capital market reform program despite the international credit crisis. It recognized the need to strengthen Indonesia's financial market structure and regulatory architecture, reflecting the intensified concerns arising from the global financial crisis. As this intensified reform process will need to extend over 2009– 2011, a post-program monitoring framework following subprogram 2 for follow-up policy measures has been envisaged (para. 83).
III. THE MACROECONOMIC CONTEXT
3. Strong position. Indonesia entered the current global financial crisis in a strong position, which was built through sound policies under favorable conditions during recent years. Economic growth averaged about 6% during 2005–2007, the fiscal position improved, the current account was in surplus, public and external debt dropped to about 30% of gross domestic product (GDP), and international reserves rose to a comfortable level sufficient to cover 6.5 months of imports. In addition, financial sector soundness became more firmly grounded with profitable and well-capitalized banks, and better supervision.
4. Withstood initial shocks. Benefiting from these strong conditions, the economy has withstood the external shocks from the international credit crisis. The global economic slowdown affected Indonesia's growth, although the impacts appear less severe than elsewhere. The economic slowdown started in the fourth quarter (Q4) of 2008 because of broad-based weakening in private demand. Growth remained near decade-highs up to Q3 2008, before slowing sharply in Q4 with the worsening external environment and anticipatory retrenchment in domestic demand. In 2009, growth weakened further to 4.4% in Q1 and 4.0% in Q2 2009 as the impacts of a deeper global economic downturn hurt externally oriented sectors. However, its impacts on Indonesia's growth are relatively smaller because the country has been less reliant
1 Despite participating in the appraisal mission, the Japan International Cooperation Agency is unlikely to cofinance subprogram 2 as no formal request has been received from the Government of Indonesia. 2 ADB 2007. Report and Recommendation of the President to the Board of Directors on a Proposed Loan and Technical Assistance Grant to the Republic of Indonesia for the Capital Market Development Program Cluster (Subprogram 1). Manila.
2 on exports to support its economic growth. Investment growth also declined as firms reduced borrowing and postponed part of their investment spending. Although private consumption slowed considerably during the peak of the financial turbulence in Q4 2008, consumer confidence remained robust, supported by a good harvest and an unconditional cash transfer program supported by the Government’s stimulus program.
5. Returning market confidence. Signs of returning market confidence have emerged as indicated by the stronger rupiah and lower interest rates and these were reflected in a recovery in the stock market (Figure 1). Government consumption also increased, in part because of election spending. External conditions are expected to remain difficult, which could weaken economic growth further. Earlier Bank Indonesia and the International Monetary Fund projected economic growth of 3%–4% in 2009. More recently, the Asian Development Outlook and the Government upgraded the growth projections to 4.3%. The economy is expected to gradually recover in 2010, lifting growth to at least 5%. Public finances remained in good health, with the budget barely in deficit in 2008 (–0.1% of GDP) and public debt ratios continuing their secular decline, providing significant additional fiscal space. Moreover, the Government and Bank Indonesia have adopted a series of mitigating measures, including lowering banks’ reserve requirements, injecting liquidity through repurchase agreements, expanding eligible collateral for short-term financing from Bank Indonesia, temporarily banning short selling, and expanding deposit insurance coverage. These factors, combined with the stronger-than-expected growth in the first half of 2009, boosted domestic and foreign investor confidence. Inflation has also eased since Q3 2008. In October 2009, Bank Indonesia kept its policy rate at a record low of 6.5% in response to slowing inflation, a reduction in the pressure on the rupiah, and continued need to support growth.
Figure 1: Indonesia Stock Exchange Composite Stock Price Index and Equity Trading Value in 2009
Source: Bank Indonesia.
6. Fiscal stimulus. While Bank Indonesia has eased monetary policy, the Government has provided fiscal stimulus to stimulate the economy. The fiscal stimulus package totaled Rp73.3 trillion (1.4% of GDP). Protecting the poor has been a high priority during the economic slowdown. The economy is poised to revive, but a slow global recovery and lingering structural impediments limit the upside. The subdued performance in the first half of 2009 has provided a basis for real GDP to grow of up to 4.3% in 2009 followed by 5.4% in 2010, compared with 6.1% in 2008. The outlook for moderate inflation means that Bank Indonesia may lower the policy rate further by the end of 2009 before pausing, while fiscal policy continues to be expansionary.
7. Strengthening of rupiah. Stabilizing the rupiah is a key objective following the earlier weakness, and the exchange rate firmed to Rp9,653 per US dollar in September 2009 from Rp11,700 in March 2009. The lift to investor sentiment from the elections and firming of the capital account contributed to a stronger rupiah during the recent months. This reflects both
3 external developments, particularly improvements in global risk tolerance, as well as the country-specific factors such as increasing market confidence in the response of Indonesian policy makers to the crisis, the sustainability of its financing needs, and the orderly elections.
8. Stock market rebound. Like the rupiah, equities on Indonesia’s stock markets have returned to pre-October 2008 levels. The Jakarta composite index rose 75.5% between December 2008 and end August 2009, outperforming the 34% increase for the MSCI-EM index for Asia. Nonresidents have moved back into the equities markets since March 2009 and are net buyers of equities.
9. Strong banking system. The direct impacts of the global financial crisis on the domestic banking system have been muted because of limited direct investment in troubled US assets. The banking system, which accounts for 80% of the financial sector’s assets, remains strong (Figure 2). Some small banks, accounting for less than 0.5% of total banking assets, have run into trouble since the onset of the crisis.3 Lending has started to expand, although not at an optimum level. The projected slowing of economic growth would affect corporations, which could increase nonperforming loans (NPLs) further. The Government has expanded deposit insurance on rupiah and US dollar deposits up to Rp2 billion.
Figure 2: Macroeconomic Performance
Stock Indexes and Exchange Rates Stable Rupiah Exchange Rate and Stock Market Recovery
% change in stock index % appreciation against USD Exchange Rate (LHS) Stock Index (RHS) Source; Bloomberg, up to 22 July 2009.
Capital Adequacy Ratio Remains Stable Non Performing Loans at Historical Low Levels
3 In November 2008, the Government recapitalized Bank Century as its liquidity problems mounted and it breached the minimum reserve requirement. In 2009, Bank IFI and one rural bank were liquidated.
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10. Improved balance of payments. After deteriorating in Q4 2008, the balance of payments position improved considerably in the first half of 2009. A contraction in imports and inflows from tourism raised the current account surplus to $3.1 billion in Q2 2009 from $2.9 billion in Q1, and a deficit of $0.7 billion in Q4 2008. Net foreign direct investment (FDI) is still positive, but decreased to $3.5 billion in the first half of 2009 from $5.2 billion in the second half of 2008. However, about the same amount of net FDI was recorded in the first half of 2008. Meanwhile, net portfolio investment was $3.9 billion in the first half of 2009.
11. Acceptable foreign reserves. A shift to net capital inflows also helped boost official foreign exchange reserves to $62.3 billion in September 2009 from $50.6 billion in February 2009.
12. Sustainable public debt. Total external debt had fallen to about 29% of GDP in 2008, down from 55% in 2004 (Table 1). Despite the large budget deficit in 2009, total public debt is estimated to increase to 33.1% of GDP in 2009. The debt service ratio over the 4-year period fell to an estimated 18% in 2008 from 27.1% in 2004. The Government will emphasize stimulating economic growth in 2009 and 2010, while keeping the fiscal deficit at prudent levels. The budget shortfall is expected to narrow to 1.6% of GDP in 2010 from 2.5% in 2009. The Government reached agreement with its development partners, including ADB, to provide more than $5 billion of standby loans,4 if conditions in international capital become too restrictive. The Government expects that the standby loans will underpin market confidence and enable it to meet its financing requirements from market sources. The Government also moved quickly to raise funds through the sale of domestic and international bonds. They sold $3 billion in 5- and 10-year notes in February 2009, and sold Rp5.56 trillion of Islamic financial certificates, or sukuk bonds. Furthermore, Indonesia has access to a total of $30 billion under bilateral and multilateral currency swap arrangements that provide additional back up for international reserves.
13. Well positioned to deal with further economic downturn. The 2009 budget law passed in November 2008 continued the spirit of fiscal discipline, while containing a number of positive budgetary measures. As the economic outlook deteriorated rapidly, the Government in February 2009 revised its revenue projections and formulated fiscal stimulus measures. As a result, Indonesia’s 2009 budget deficit has risen from 1.0% to 2.5% of GDP. The expanding deficit together with large debt repayments increased the Government's financing needs significantly. Better market conditions have helped in meeting its financing requirements from the market. As of mid-August, the Government had raised more than 80% of its financing needs for all of 2009 from capital markets.
Table 1: Key Macroeconomic Indicators for Indonesia, 2004–2009
Fiscal Year Item 2004 2005 2006 2007 2008 2009a A. Income and Growth 1. GDP per Capita ($, current) 1,188 1,291 1,662 1,916 2,240 2,250 2. GDP Growth (%, in constant prices) 5.0 5.7 5.5 6.3 6.1 4.3 a. Agriculture 2.8 2.7 3.4 3.5 4.8 4.2 b. Industry 3.9 4.7 4.5 4.7 3.7 2.5 c. Services 7.1 7.9 7.4 8.9 8.9 6.0
4 ADB. 2009. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Republic of Indonesia for a Public Expenditure Support Facility Program. Manila.
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Fiscal Year Item 2004 2005 2006 2007 2008 2009a B. Saving and Investment (current and market prices, % of GDP) 1. Gross Domestic Investment 24.1 23.6 24.1 25.0 27.6 24.9 2. Gross National Saving 24.9 23.7 26.8 27.4 27.7 25.2 C. Money and Inflation (annual % change) 1. Consumer Price Index (average) 6.1 10.5 13.1 6.4 9.8 5.0 2. Total Liquidity (M2) 8.1 16.4 14.9 18.9 14.6 17.5 D. Government Finance (% of GDP) 1. Revenue and Grants 17.6 17.9 19.1 17.9 19.8 14.8 2. Expenditure and Onlending 18.6 18.4 20.0 19.2 19.9 17.4 3. Overall Fiscal Surplus (Deficit) (1.0) (0.5) (0.9) (1.3) (0.1) (2.6) E. Balance of Payments 1. Merchandise Trade Balance (% of GDP) 7.9 6.1 8.1 7.6 4.5 5.1 2. Current Account Balance (% of GDP) 0.6 0.1 2.9 2.4 0.1 2.0 3. Merchandise Export ($) Growth 10.4 22.9 19.0 14.0 18.0 (23.0) (annual % change) 4. Merchandise Import ($) Growth 28.0 37.2 6.3 15.0 36.0 (30.3) (annual % change) F. External Payments Indicators 1. Gross Official Reserves (in $ billion) 36.3 34.7 42.6 56.9 51.6 62.1 (in months of imports of goods) (5.0) (4.4) (4.7) (4.7) (6.0) (6.5) 2. External Debt Service (% of exports of goods 27.1 17.3 24.8 19.4 18.4 31.0 and services) 3. Total External Debt (% of GDP) 55.4 46.3 34.8 32.6 29.2 30.9 G. Memorandum Items 1. GDP (current prices, Rp trillion) 2,295.8 2,774.3 3,339.5 3,949.3 4,954.0 5,414.7 2. Exchange Rate (Rp/$, average) 8,934.6 9,712.0 9,020.0 9,136.2 9,678.3 10,400 3. Population (million) 216.4 221.3 222.8 225.6 228.5 231.4 — = not available, ( ) = negative, GDP = gross domestic product. a Asian Development Bank estimates. Sources: Bank of Indonesia, Central Bureau of Statistics, International Monetary Fund, and Asian Development Bank estimates. The data presented has also taken into account changes in data released by the Government.
14. Continuing reform agenda. Indonesia has taken important steps to intensify its structural reform agenda, enhance the investment climate, improve public infrastructure, and strengthen financial sector intermediation. A time-bound investment policy package was introduced subsequently in February 2006, and the Investment Law was passed in March 2007. The Government prepared and undertook a inter-ministerial review of a presidential regulation on the implementation of the 2007 Investment Law. An infrastructure reform package was adopted in 2006 to support the investment policy package. Notable recent reforms include the passage in September 2008 of the amended Income Tax Law, which reduces corporate and personal rates. Economic policy packages covering the investment climate have been introduced in each of the last 3 years, and major reforms of customs administration are underway.
15. Need for continuing capital market reforms. Indonesia has adopted the appropriate macroeconomic policies to arrest the impact of the crisis and maintain steady growth. Its macroeconomic responses have been lauded.5 However, the current crisis also highlights the longer-term challenges of improving the structural resilience of Indonesia's financial sector through accelerated capital market development and expanding and enhancing the regulation and governance of its capital markets. Confidence that credit and financial markets will continue to function properly will be crucial for supporting the further expansion of economic activity. Short-term measures to boost liquidity and ward off pressure on balance sheets will need to be
5 International Monetary Fund. 2009. Report on the Article IV Consultation. Washington, DC (June).
6 complemented by medium-term efforts to further improve financial supervision and, through better governance of market institutions, to safeguard financial systems. In this environment, the capacity of the Indonesia capital markets must be expanded in a measured way to reduce refinancing risks as capital markets are still small compared to the banking sector. The development of capital market capacity which can provide longer-term financing will also rebalance and create enhanced resilience in the financial sector. These enhanced domestic capital markets can be an efficient source of finance for the Government and Indonesian corporations, while providing a safe and stable environment for investors. Infrastructure development will also need a deep and vibrant domestic capital market.
16. The medium-term development plan. Continued fiscal prudence has provided the Government with the fiscal space needed to meet Indonesia’s development challenges. The medium-term national development plan, 2004–20096 provides a clear set of targets that the Government wants to meet by the end of the plan period. The plan sets out a good policy framework for the reforms and investments needed for each sector. Some adjustment in growth rates for 2009 and 2010 has now been acknowledged because of the impact of the global crisis. Policies envisaged under the Government’s medium-term macroeconomic framework aimed to help mitigate economic vulnerabilities, improve the business climate, and encourage investment.
17. Key constraints on accelerating GDP growth include the absence of (i) a stable and consistent legal and regulatory environment, (ii) well-developed capital markets and nonbank financial sector, and (iii) adequate skills and institutional capacity within public and market institutions. The 1997 crisis raised awareness of the risks associated with a growth-oriented development agenda without a deep and diverse financial sector. The financial system is still dominated by banks, although increasing attention is being paid to the nonbank financial sector. In November 2004, the Government approved an action plan for the nonbank financial sector in consultation with ADB. The action plan included measures to support and implement the Government’s capital market master plan, 2005–2009 (CMMP). The CMMP focuses mainly on strengthening capital markets by improving surveillance, increasing legal certainty, strengthening the role and quality of market participants, expanding products, and developing Islamic financial products.
18. Financial sector reforms. Underscoring the importance of achieving a deep and diverse financial sector, two financial sector policy packages (FSPPs) were issued in July 2006 and July 2007. Both packages promoted financial sector reforms through clear policy, programs, and outputs. The policy actions outlined in the packages covered a number of areas with a time frame for actions up to July 2008, including strengthening financial system stability through greater coordination across regulators. Progress on the actions has been largely on track. ADB provided significant inputs to the preparation of the two FSPPs.
19. Capital market master plan. ADB has also been involved in the Government’s reform process through policy dialogue and technical assistance (TA).7 This regulatory reform TA has provided support to implement the main elements of the action plan (para. 17) and the CMMP. These measures have established a good basis for further market development. While the CMDPC is predominantly focused on development of the capital market through the implementation of the CMMP, it also embraces some of the broader issues covered under the
6 Presidential Regulation 7/2005 on the Medium-Term National Development Plan issued on 19 January 2005. 7 ADB. 2002. Technical Assistance to the Republic of Indonesia for Establishing a Financial Services Authority. Manila.
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FSPPs. The CMMP for 2010–2014 is proposed to be developed through ADB TA (footnote 2) during 2009.
20. Other supporting programs. ADB is also involved in a series of program lending operations in conjunction with the World Bank’s development policy loans (DPLs). These will support the Government’s broad-based, cross-cutting, medium-term investment climate and governance reform agenda. The first DPL was approved by the World Bank in 2004. ADB provided parallel support in 2004 through financial sector and state-owned enterprise (SOE) reform programs. In 2005, at the Government’s request, ADB approved the Development Policy Support Program (DPSP).8 The second9 DPSP was approved in 2006, the third10 DPSP in 2007, and the fourth11 DPSP in 2008, while the fifth DPSP is being processed for consideration in 2009. The DPSP series is embedded in the Government’s medium-term national development plan, 2004–2009. In addition to the Public Expenditure Support Facility (footnote 4), a Countercyclical Support Facility was also approved in 2009 at the request of the Government.12
21. ADB’s country strategy and program. 13 Financial sector deepening that facilitates domestic resource mobilization was identified as one of the five key areas for ADB intervention under the country strategy and program (CSP), 2006–2009. The CSP recommends using a single-tranche cluster approach for program loans to support the Government’s medium-term reform agenda. The CSP also envisages TA in support of these loans. The CMDPC evolves from the Government’s medium-term national development plan to support its financial sector reform agenda in line with the CSP, with a principal focus on the development of capital markets in Indonesia (Figure 3).
8 ADB. 2005. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Republic of Indonesia for Development Policy Support Program. Manila. 9 ADB. 2006. Report and Recommendation of the President to the Board of Directors on a Proposed Program Cluster and Loan to the Republic of Indonesia for the Second Development Policy Support Program. Manila. 10 ADB. 2007. Report and Recommendation of the President to the Board of Directors on a Proposed Program Cluster and Loan to the Republic of Indonesia for the Third Development Policy Support Program. Manila. 11 ADB. 2008. Report and Recommendation of the President to the Board of Directors on a Proposed Program Cluster and Loan to the Republic of Indonesia for the Fourth Development Policy Support Program. Manila. 12 ADB. 2009. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Republic of Indonesia for the Countercyclical Support. Manila. 13 ADB. 2006. Country Strategy and Program (2006−2009): Republic of Indonesia. Manila.
8
Figure 3: National Medium-Term Development Plan and Capital Market Development Program Cluster Loan
Medium-Term Development Plan (2004–2009)
Realizing a safe and Enhancing the prosperity Realizing a just and peaceful Indonesia of the Indonesian people democratic Indonesia
Consolidation of macroeconomic stability
Fiscal Program Financial Sector Financial Sector Increase revenues Program Policy Package Increase efficiency and effectiveness of government expenditure Enhance government foreign loan management
Capital Market Master Nonbank Financial Sector Plan Enhance efficiency in regulation and Banking Sector (2005–2009) supervision Strengthen structure of banks Autonomous regulation Harmonize sector laws in accordance Improve coordination among Enhance human with international standards regulators resource skills Improve financial and operational Enhance supervisory and Optimize information autonomy regulatory efficiency technology Develop risk-based system of Formulate early warning system Formulate risk-based supervision Gradually implement the 25 Basel supervision Coordinate different regulators Core principle for effective banking Addressed through Develop early warning system and supervision financial stability assessment program Enhance governance Gradually implement IOSCO, OECD, Strengthen risk-based system of and IAIS principles of supervision supervision Enhance governance Increase channel of credit to SMEs Capital Market Facilitate and/or provide growth of new Develop microfinance institution Master Plan products Strengthen and consolidate the 2010-2014 banking industry through increased capital requirements Supported by ADB through
CMDPC Subprogram 2, 2009 CMDPC Subprogram 1, 2007
Post-Program Monitoring Framework for Follow-up Policy Measures – Sep 2009–June 2011
CMDPC = Capital Market Development Program Cluster, IAIS = International Association of Insurance Supervisors, IOSCO = International Organization of Securities Commissions, OECD = Organisation for Economic Co−operation and Development, SME = small and medium-sized enterprise. Source: Presidential Regulation 7/2005 on the Medium-Term National Development Plan issued on 19 January 2005; and Capital Market Supervisory Agency, Ministry of Finance. Indonesian Capital Market Master Plan 2005−2009. Republic of Indonesia.
IV. THE SECTOR
A. Sector Description and Performance
22. Lack of depth. Although the Indonesian capital market had been the best performing in the region, the breadth and depth of the market and the enforcement of regulation and
9
supervision remained key issues to be addressed. At an M2-to-GDP ratio of 49.5% at the end of 2008,14 Indonesia lags behind regional competitors such as Malaysia and Thailand, which have ratios of more than 100%. The long-term debt market had been constrained by delays in pension and insurance sector reforms. Much liquidity was locked up in government bonds. In 2008, with total banking assets as a percentage of GDP of 43.8%, Indonesia had the smallest market in this region (Table 2). With equity market capitalization as a percentage of GDP of 21.8% in 2008—it dipped because of the global crisis but has since improved—Indonesia had the smallest market, with Hong Kong, China ahead of the pack, followed by Singapore, Republic of Korea, Malaysia, People's Republic of China (PRC), the Philippines, and Thailand. Indonesia also had the smallest debt market of the countries in Table 2 with the percentage of bonds outstanding to GDP of 13.6%. A more detailed sector analysis is in Appendix 2.
Table 2: Structure of the Financial System in selected Asian Economies (% of gross domestic product)
Bank Assets Equity Market Equitization Bonds Outstanding Economy 1996 1997 2004 2007 2008 1996 1997 2004 2007 2008 1996 1997 2004 2007 2008
PRC 93.3 124.6 176.4 163.1 156.3 13.8 11.2 23.5 13.2 40.4 6.5 12.9 24.9 50.0 52.4
Hong 152.5 205.1 337.5 444.6 640.9 282.6 234.5 519.5 501.0 613.6 23.4 26.0 46.3 47.4 39.4 Kong, China Indonesia 54.0 31.1 14.6 49.8 43.8 40.3 12.2 28.8 41.0 21.8 3.1 1.9 22.6 20.8 13.6 Republic 113.6 37.9 130.1 93.5 168.0 26.1 14.4 50.0 97.63 56.3 53.1 25.2 83.3 136.5 85.7 of Korea Malaysia 139.8 100.9 169.0 159.6 172.9 299.1 93.2 153.3 156.0 89.3 71.4 57.0 90.0 84.6 76.0 Philippines 73.9 56.1 66.5 63.2 67.2 97.4 37.7 33.0 60.0 31.1 32.7 22.4 28.4 36.0 34.2 Singapore 79.3 122.0 176.8 185.4 259.7 164.2 110.8 202.3 196.0 142.4 26.4 24.7 73.1 69.9 66.8 Thailand 140.1 79.7 129.2 103.6 114.4 53.3 15.1 71.4 69.2 28.0 10.1 7.1 41.1 54.0 52.4 PRC = People’s Republic of China. Sources: International Monetary Fund International Financial Statistics; Bank for International Settlements; Asian Development Bank; Asian Bonds Online; and Ghosh, Swati R. 2006. East Asian Finance: The Road to Robust Markets. Washington, DC: World Bank.
23. High concentration of banking institutions. Banks account for more than 80% of financial sector assets. Despite its size and recent improvements, the Indonesian banking sector is not a source of long-term capital as more than 90% of bank deposits have a maturity of less than 1 year. As a reaction to the 1997 crisis, bankers in general are risk averse in their approach to lending and are appropriately focused on working capital financing given their deposit base. As a result, the growth of loans has stayed below deposit growth, making banks very liquid. While interbank lending has been improving since November 2008 and rupiah liquidity in the system is sufficient, reports suggest that it is not well distributed. Larger banks typically are liquid, while smaller banks are facing problems. Other indicators suggest the banking sector remains in relatively good health overall, with banks lifting their capital-to-assets ratio and only experiencing a marginal increase in nonperforming loans during Q1 2009.
24. Undeveloped nonbank financial subsector. The nonbank financial subsector still accounts for less than one-fifth of total financial assets. Total assets of insurance companies accounted for about 5% of GDP as of June 2008, and pension funds net assets were only about 2% of GDP. The Government considers the development of the nonbank financial sector urgent and imperative. Indonesian institutional investors are small and have not been a source of long-
14 The M2-to-GDP ratio (demand, savings, and time deposits, or M2, divided by the output of goods and services, namely GDP) is a common measure of financial depth.
10 term capital. Indonesia’s pension funds and insurance companies invest a significant portion of their resources in short-term bank deposits. Total market capitalization of Indonesia stock exchange (IDX) as of October 2009 accounted for 36.1% of GDP, and the total value of corporate bond issuance was 1.3% of GDP.
25. Stronger governance and regulations needed. Financial sector regulation and supervision are under the authority of two main supervisory authorities. Banks are regulated and supervised by Bank Indonesia, the central bank, which has been strengthened significantly in the aftermath of the 1997 crisis and has been given financial and operational autonomy. The Bapepam-LK was initially the Capital Markets Supervisory Agency (Bapepam) established in 1976 under Presidential Decree No. 52/1976, and it has weaker powers and capacity compared to Bank Indonesia. In 2005, Bapepam-LK responsibilities were expanded. It is now responsible for the regulation and day-to-day supervision of capital markets as well as the nonbank financial institutions, including insurance and private pensions, as an integral part of the Ministry of Finance (MOF). The MOF is responsible for high-level policy matters, and Bapepam-LK exercises delegated authority in relation to the conduct of investigations, inspections, and other regulatory functions. The merger and the endorsement of a plan for improvements in the regulatory and supervisory structure of the newly created Bapepam-LK were significant steps toward strengthening supervision of nonbank financial services and the capital markets. A senior (echelon 1)15 official was appointed to head the merged entity, paving the way for a consolidation of nonbank financial institution supervision with the supervision of the capital markets.
26. In 1999, Parliament passed the Banking Law to insulate the regulatory and supervisory framework from political interference. The legislation required the establishment of the Consolidated Supervisory Authority for Financial Services (OJK) by the end of 2002 to be able to cope with financial conglomeration and innovation, and to lower the cost of regulation by making efficient use of scarce resources. However, prudential regulation of banks focusing on their safety and soundness and systemic risk is fundamentally different from the investor protection needs of securities or capital markets, which are focused on disclosure, fairness, and prevention of fraud through enforcement of business rules and punishment of offenders. As became evident following 1999, merging two different approaches and cultures poses significant challenges, not least of which is the need to manage the risks of a decline in the quality of supervision during the transition phase. This challenge is more complex in Indonesia, where the two entities to be merged differed sharply in terms of independence, salary structures, and regulatory capacity and were operating in areas where systemic risks remain a key concern. Recognizing these difficult institutional issues and the systemic risks, Parliament amended the Banking Law in December 2003 and postponed the establishment of the OJK from 2002 to 2010.
27. Bapepam-LK has an intensive program to improve the capacity of its entire staff. ADB and the Australian Agency for International Development (AusAID) are supporting this transformation and providing training and human resource development assistance to Bapepam-LK. The MOF supports further strengthening of Bapepam-LK’s financial and operational autonomy through annual budget allocations. Since 2007, steps have been initiated to enhance Bapepam-LK’s operational and financial autonomy through legal and regulatory measures designed to provide stronger regulation of capital markets and the contractual savings industry. Major steps were also undertaken to strengthen the associated institutional
15 All structural positions in Indonesia’s national civil service are grouped into echelons, with echelon 1 being the most senior.
11 structures of MOF and Bapepam-LK through restructuring of key departments, combined with significant pay increases. They were also given the authority to recruit staff from the market.
28. Shallow equities market. Indonesia’s equities market has improved steadily since 2002 and was among the best performers in the region in 2004 and 2005. In 2006, it was among the top three stock markets in the world with growth of about 50% in market capitalization. Despite the growth, Indonesia’s equities market remains one of the smallest in Asia and the Pacific. The number of listed companies increased from 336 in 2005 to 401 as of July 2009 with total market capitalization of Rp1,719 trillion. In 2008, the downturn in the global economy had a significant impact on the composite index of the IDX and its market capitalization in 2008, but the market has now recovered (para 8).
29. Promising fixed-income market. Compared to other markets in Asia, the bond market in Indonesia is still small. The total bond market dropped to 13.6% of GDP in 2008 from 22.2% in 2007. At 12.3% of GDP, the government bond market in Indonesia is among the smallest in Asia. Only Hong Kong, China at 9.1% of GDP is smaller, but it has a sizeable corporate bond market at 30.4% of GDP. All the other countries in the Association of Southeast Asian Nations (ASEAN) have much larger bond markets as a percentage of GDP. Malaysia is the biggest (76.0%), followed by Singapore (72.0%), Thailand (52.4%), the Philippines (34.2%), and Viet Nam (14.2%).
30. Government bonds. However, the Government of Indonesia is trying to tap the bond market as a source of financing for economic development and raising funds, including through buy-back arrangements and issuance of sovereign Islamic bonds (sukuk) in 2009. Maturities go out to 20 years, considerably longer than in 2000. While the credit default swap premiums increased steadily from 2007 to the peak in September 2008, it started to decline from December 2008 and fell substantially to pre-crisis levels as of August 2009.
31. Banks hold about three-quarters of government bonds by value. The Debt Management Office (DMO) has followed a strategy of consolidating bond issues—through buy-backs and asset swaps—and has sought to build benchmark issues. The DMO issued its first treasury bills in June 2007 with a 12-month tenor. Retail investors' participation increased with the introduction of retail government bonds, issued exclusively to Indonesians in the primary market in July 2007. A system of primary dealers was introduced in December 2006, and these dealers have been providing two-way quotes. In the secondary market, an over-the-counter market and the exchange market coexist, both offering avenues for trading of all debt securities.
32. Limited corporate bond market. The corporate bond market in Indonesia is insignificant compared to government bond markets. Corporate bonds account for only about 1.3% of GDP compared with about 12.3% of GDP for the government bond market. This percentage is also low compared to neighboring countries—Republic of Korea (47.0%); Malaysia (34.6%); Hong Kong, China (30.4%); Singapore (29.0%); Thailand (10.4%); and the Philippines (3.3%). However, the potential for developing the corporate bond market in Indonesia is vast given the number of infrastructure development projects in the pipeline, but this will require a more comprehensive policy in combination with concerted efforts from the Government and corporate sectors. Greater pricing transparency is expected in the future with the establishment of Bond Pricing Agency and the Government's benchmark issues.
33. Market intermediaries. The IDX is the national stock exchange based in Jakarta. It was previously known as the Jakarta Stock Exchange before its name was changed in 2007 following the merger with the Surabaya Stock Exchange. The new merged exchange is
12 operating successfully. However, Indonesia still maintains two systems for clearing, settlement, and deposits: the Indonesian Central Securities Depository (KSEI) and the Indonesian Clearing and Guarantee Corporation (KPEI). IDX, KSEI, and KPEI are self-regulating organizations with the authority to set rules and oversee the activities of broker-dealers, and custodian banks dealing in securities and bond trading. Indonesia has 158 securities brokerages. Pefindo, established in 1994, is the country's largest rating agency. It is an affiliate of Standard and Poor’s and has adapted its rating methodology. The only other rating agency is PT Fitch Rating Indonesia, incorporated in 2006. An inability to obtain and/or enforce timely commercial judgments has hampered the development of the financial sector and capital markets in particular. Other agencies have provided support to the judiciary to enhance its capacity, but more assistance is needed.
34. High trading cost. Total trading cost includes commission and fees charged for trading activities. Based upon a market survey, Indonesia's total trading cost of 72 basis points in 2005 had declined to 53 basis points in 2008. Nonetheless, Indonesia is the second-most cost- inefficient market in Asia, trailing only the Philippines. In 2008, most countries had more efficient trading costs—Malaysia (41 basis points); Thailand (42); Singapore (36); and Hong Kong, China (41). However, these costs are estimates and comparisons are problematic.
35. Regional integration of equity markets. Regional integration can facilitate domestic capital market development as well as global integration by providing the liquidity, scale, and capacity to compete globally and manage volatility more effectively. In one significant step toward regional integration, the ASEAN capital market regulators, through the ASEAN Capital Markets Forum, have developed an Integration Plan to anchor integration of capital markets. Additionally, five ASEAN exchanges—Bursa Malaysia, Indonesia Stock Exchange, Philippine Stock Exchange, Singapore Exchange, and the Stock Exchange of Thailand—had signed a memorandum of understanding (MOU) on 23 February 2009 to establish an electronic trading platform by the fourth quarter of 2010. A virtual ASEAN Board will be established, on this board, each of the five exchanges will list its top 30 stocks by market capitalization. These 150 companies represent around 60% of the total market capitalization of the five markets.
36. Need for stronger corporate governance. In March 2005, a World Bank review concluded that a number of initiatives were underway that could eventually result in compliance with the Organisation for Economic Co-operation and Development (OECD) principles. 16 However, practices and enforcement diverge. ADB has supported the development of a corporate governance code for SOEs and strengthening of the governance standards under the listing requirements for the Jakarta Stock Exchange.17 Guidelines to improve performance and corporate governance at state-owned banks were issued in February 2007. Bapepam-LK has tried to increase the standards of management of financial and public Institutions by issuing minimum standards for commissioners and directors of regulated entities and mandatory internal audits for public firms and public issuers. In its 2008 Doing Business report,18 the World Bank rated investor protection in Indonesia in 2007 at slightly below the OECD average. The indexes range from 0 and 10, with higher values indicating greater disclosure, greater liability of directors, greater powers of shareholders to challenge a transaction, and better investor
16 The OECD principles provide specific guidelines for policy makers, regulators and market participants in improving the legal, institutional and regulatory framework that underpins corporate governance, with a focus on public traded companies. 17 ADB. 2001. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Republic of Indonesia for State-Owned Enterprise Governance and Privatization Program. Manila. 18 World Bank and International Finance Corporation. 2008. Doing Business Report 2008 is the fifth in a series of annual reports investigating the regulations that enhance business activity and those that constrain it.
13 protection. Particularly noteworthy was Indonesia's score of 9.0 in the disclosure index, compared with a regional average of 5.0 and an OECD average of 6.4. On the other hand, the country scored only 3.0 in the shareholder suits index, compared with a regional average of 6.3 and an OECD average of 6.5.
37. Sharia-based capital market products. Islamic finance in Indonesia is newer than conventional finance, but has grown rapidly. Bank Indonesia has developed a blueprint for sharia banking derived from Islamic values. Sharia-based capital market products were first introduced in Indonesia by a sharia investment fund in mid-1997. The Government is working on a comprehensive framework for Islamic finance covering the legal framework, market rules, accounting, and tax structure to support its growth. Bapepam-LK has been involved in discussions with the Indonesian Accounting Association to formulate the issuance of sharia accounting standards. In July 2008, the Parliament approved the issuance of government sukuk worth $2 billion. With credit markets tight, the Republic of Indonesia sold a $650 million 5-year global sukuk in April 2009. This development has been seen as a strong indication of the Government’s increased attention to developing sharia finance.
38. Derivatives. Indonesia has exchange-traded derivatives and over-the-counter (OTC) derivatives. Exchange-traded derivatives are traded on the IDX, whereas OTC derivatives are traded mostly by banks under the oversight of Bank Indonesia. IDX offers three types of exchange-traded derivatives: (i) stock options, (ii) index future contracts, and (iii) rights or warrants. The exchange-traded derivatives market in Indonesia is small. The OTC derivatives are more actively traded by banks in the foreign exchange market. When the economic recovery has solidified, Bank Indonesia, in coordination with Bapepam-LK and IDX are planning to introduce interest rate and bond futures to further develop bond markets.
39. Newly introduced financial products. New financial products include (i) exchange- traded funds, (ii) asset-backed securities (although no company has issued such securities since the regulations were introduced), (iii) single stock futures, and (iv) stock lending and borrowing. A presidential decree on secondary mortgage financing was issued in February 2005 establishing the Secondary Mortgage Corporation (PT Sarana Multigriya Finansial). Its function is to purchase qualified mortgages from financial institutions and issue bonds backed by these assets. It recently issued its maiden instrument in the form of the Asset-Backed Exchange- Traded Fund in February 2009, based on the securitization of the mortgage portfolio of Bank Tabungan Negara.
40. Contractual savings industry. The insurance industry is still small. The ratio of premiums to GDP rose from 1.6% in 2006 to 1.9% in 2007. The gross premiums collected by the insurance industry in 2007 reached Rp74.51 trillion, 42% higher than the previous year's figure of Rp52.42 trillion. Since the Asian financial crisis, the Government has introduced some important regulatory changes governing insurers, including a new risk-weighted capital adequacy regime to encourage mergers, risk-based supervision, and an increase in the capital requirements for new insurance companies. The industry is heavily concentrated, with the top five general insurance companies accounting for 51% of general insurance assets and the top five life insurance companies accounting for 55% of life insurance assets. The licenses of eight companies—five life insurance and three general insurance—were withdrawn in 2006. The Government still needs to address the remaining one state life and two insolvent general insurance companies. Insurance companies currently invest about 25% of their assets in short- term deposits. The insurance industry needs to be consolidated into fewer but stronger companies. Policy holders must be protected and standards raised in anticipation of reductions to barriers to entry with equal treatment under freer service agreements. The quality of
14 professional services to the pension and insurance industry also needs to be improved, especially actuaries and accountants but also asset managers, to shift toward risk-based supervision.
41. The Government regulation 81/2008 requires the general insurance companies to increase their minimum equity from Rp40 billion to Rp100 billion over a transition period from 2010 to 2014. Higher capital requirements imposed on insurance firms may foster consolidation of the industry. Takaful insurance19 is also expected to emerge in Indonesia.
42. Small pension sector. In Indonesia, the pension sector is small, accounting for less than 4.7% of GDP in assets, compared with Thailand at 8.4%, Malaysia at 57.0%, and Australia at 75.0%. Only 12.0% of the workforce is covered by public pension and old-age savings programs, provided by PT Jamsostek for private sector workers, by PT Taspen for civil servants, and by PT Asabri for the military. Less than 2% of the workforce is covered by voluntary private pensions. The Private Pensions Law 11/1992 will be reviewed and amendments will be submitted together with the amendments proposed to the Capital Market Law and the Insurance Law. The uncertainties that prevent the growth of the pension industry need to be resolved together with the uncertain implementation of Law 40 on the National Social Security System and debates on the funding of benefits under Law 13 of 2003 on Labor.
43. Bapepam-LK, which oversees the voluntary pension schemes, is taking steps to improve the private pension industry, particularly to increase risk-based supervision. To enhance the performance of pension fund industry, the Ministerial Decree on Pension (Decree 199/PMK- 010) was issued in December 2008 to allow for investment in a wider range of domestic instruments.
44. Accounting and auditing standards. The Indonesian Institute of Accountants establishes accounting, auditing, and ethics standards and is also involved in certification and education. MOF had prepared a draft public accountancy law, which was expected to address the legal liability of accountants and independent public oversight system. The Indonesia Financial Accounting Standards consist of International Financial Reporting Standards and US Generally Accepted Accounting Principles-based standards, as well as sector-specific rules. The Capital Market Law requires public companies to file audited financial statements with Bapepam-LK and also provides for Bapepam–LK to establish additional accounting requirements for the capital markets. Under the Capital Market Law, issuers and public companies are required to have their financial statements audited by the auditors registered with Bapepam-LK. These auditors must comply with the Code of Ethics and professional standards.
B. Issues and Opportunities
45. Need for reforms. Capital market reforms are crucial to increasing financial sector resilience, protecting development momentum, and accelerating poverty reduction. Since the 1997 crisis, Indonesia has undertaken key financial reforms, restoring the banking sector to solvency and profitability. However, economic growth has not returned to pre-crisis levels. Indonesia needs investments, especially in infrastructure, but the domestic financial sector is not yet able to provide the longer-term credits that would not involve refinancing risks. The financial sector is shallow and dominated by banks. Bank lending balance sheets make them unsuited to meet the nation’s need for long-term financing. The nonbank financial sector,
19 The word Takaful is derived from the Arabic root word kafala, which means mutual guarantee or protection.
15 particularly the capital markets, offers a major opportunity to reinvigorate growth thorough more efficient intermediation.
1. Enhance Price Information and Price Discovery
46. The debt market has long suffered from a lack of price transparency for both government and corporate bonds. No entity is able to offer a credible and reliable fair valuation service to the market. The availability of reliable and timely information is essential for capital markets to function efficiently and for the prices to reflect the fundamentals. Subprogram 1 supported the issuance of rules to establish a bond pricing agency. These measures were aimed at addressing the major regulatory failures in 2005 that resulted in the mispricing of fixed-income securities in mutual funds, which caused fund investors to lose confidence. The bond pricing agency, which has been operational since July 2009, is expected to provide an independent and objective fair value of all bonds each day. The OECD principles of good governance suggest that firms should disclose all material information in accordance with high standards of accounting and financial and nonfinancial disclosure. Previously, there was no mandatory post- trade reporting regulation for market participants in the government and corporate bond markets. Further, no mechanisms were in place to enable consolidation of market data or provide real- time information. Before November 2007, an OTC fixed-income trading system that could be used to quote prices, review product information, and facilitate negotiation and trade reporting for government and corporate bonds was available, but the dealers had few incentives to use it. The system was replaced in November 2007 by a centralized trading platform, and the transactions executed on the exchange are required to be reported in real time to the central trade aggregator. For trades outside the exchange, the reporting time from trade execution also needed to be shortened. Rules and procedures to enable prompt public disclosure of changes in beneficial ownership of officers, directors, and shareholders with 5% holding of public companies needed to be improved in line with international best practice.
2. Develop Deeper and More Liquid Capital Markets
47. Indonesia's markets are smaller and the secondary markets are less liquid than those of most other Southeast Asian economies (para 28). Indonesia’s equity market has been improving steadily since 2002. While the market value increased to $204.8 billion in 2007— before dropping to $91.4 billion in March 2009 because of the global crisis—Indonesia remains the fourth-smallest market in Asia and the Pacific. The biggest constraint on the development of the bond markets has been the limited liquidity in the secondary markets, which affects the efficiency of the market overall. Against this background, Indonesia faces two challenges: (i) catching up with its neighbors, and (ii) ensuring that it is able to participate in efforts to integrate regional markets and economies.
16
Figure 4: Efficiency of the Indonesian Securities Markets
C Liquidity Investor base low Institutional investors limited Savings rate low at 25% Free float small A B Not many listed companies Information to price Transaction costs accurately (explicit taxes, commissions, Transaction costs reduced but fees, and impact) still high compared with other exchanges in Asia and the Pacific Corporate 90% of the bonds traded are governance government securities Crowding out other instruments Complementary True yield curve yet to emerge Highly concentrated Market infrastructure structure Bond Pricing Agency ownership of the publicly and mechanisms operationalized listed corporate sector Short-selling and Dealers are mostly banks Limited float JSX and SSX margin trading Need to improve transparency Corporate governance merged need revision in pricing needs strengthening Settlement T+3 Not many hedging Two credit rating agencies Minority shareholders (3 days after the instruments date of trade) Limited issues of private debt need legal empowerment Not conducive tax papers Bankruptcy law needs Investor protection environment fund to be set up by Disclosure needs improvement revision 2010
JSX = Jakarta Stock Exchange, SSX = Surabaya Stock Exchange. Source: Adapted from Ghosh, Swati R. 2006. East Asian Finance: The Road to Robust Markets. Washington, DC: World Bank
48. Issuance and market for corporate and government debt securities. Overall liquidity in government bonds has improved, but the market is still volatile. The government bond market operates with daily intraday spreads of 50–100 basis points, which is high for the government segment, because of the lack of efficient market makers20 and excessive control over price formation by foreign intermediaries that control the major trade flows. Ownership distribution is also skewed towards banking intermediaries that act more like investors than dealers. A lack of interagency policy coordination because of overlapping regulatory functions between the DMO and Bank Indonesia hampers development and adds to market distortions. Regular updates on the annual auction calendar for government bonds were needed to be provided to market participants to provide clarity on issuance expectations as otherwise this increase the risk to participants, which raises the cost of debt and reduces the attractiveness of the market. The lack of market making by intermediaries and the absence of credible benchmarks or any form of hedging mechanism have also affected price formation. The continuous replacement of Bank Indonesia securities with short-term treasury bills with a greater range of maturities is also required to develop the short end of the yield curve. The suitability of allowing nonbank primary dealers to participate in the Bank Indonesia repurchase agreement window should also be considered to provide equal opportunities for all market participants.
49. Another issue that affects market efficiency is Bank Indonesia’s scripless securities settlement system, which undertakes the depository activity for government bonds but does not provide direct access for nonbanking institutions that are not subregistries. The level of system integration with the subregistries is poor and contributes heavily to operational costs and the
20 A brokerage or bank that maintains a firm bid and ask price in a given security by standing ready, willing, and able to buy or sell at publicly quoted prices.
17 lack of straight-through processing 21 capabilities for the market. Issuance of government securities would improve with a coherent policy for debt issuance, a proper primary dealer system, and infrastructure to support the primary and secondary market for government debt securities. Poor liquidity in the corporate segment is the result of the limited supply of high- quality corporate bonds. Because the supply is inadequate to meet demand, institutional investors such insurance and pension funds buy up most issues and hold them to maturity. ADB is providing TA to Bapepam-LK (footnote 2) to create a more liquid, transparent, and competitive bond market with wider and more harmonized access throughout the industry.
50. Repurchase markets. The Government began a market for repurchase agreements in 2004 and launched a master repurchase agreement in 2005. However, market participants have major problems with the agreement because it lacks clarity with regard to its terms and conditions and the extent to which parties can exercise their rights if a counterparty defaults. Only five institutions have executed the master repurchase agreement to facilitate repurchasing transactions. Another key hurdle is the master repurchase agreement structure, which is based on a sale and buy-back with full legal transfer of securities, resulting in the participants being taxed at both stages of the transaction. Intensification of these reforms is badly needed to initiate the development of the repurchase markets.
51. Equity market liquidity. In 2008, 8% (29 companies) of the 394 listed companies were not traded at all, while 55% (189 companies) accounted for less than 0.1% of the total trading volumes on the IDX. The main reasons for the lack of liquidity of these shares are (i) concentrated share ownership causing minimal real free float, (ii) an absence of corporate action plans, (iii) weak investor relations, and (iv) insufficient provision of information to the public. As a consequence, the market remains small and illiquid, and this restricts the development of domestic institutional investors. The process of listing is unnecessarily cumbersome and time-consuming, and companies have few incentives to do so. Taxation has been a major issue, as unequal tax treatment of institutions has significantly affected the participation of market intermediaries, especially securities firms. Stock option products were launched in 2006, but they did not find much favor with the market as the rules were not considered attractive.
52. Indonesia’s capital market needs supporting infrastructure. In addition to repurchase markets (para. 50), securities lending, margin trading (particularly short selling), and a derivatives market need to be developed. The lack of these instruments and facilities reduces liquidity and increases transaction costs. Liquidity will also be improved through measures to widen the investor base, in part by encouraging the introduction and issuance of rules for different types of products to suit the different risk preferences of investors. These include exchange-traded funds, real estate investment trusts, municipal bonds, asset- and mortgage- backed securities, and sharia products. Assistance was also required for the introduction of sharia accounting standards for Islamic finance instruments. The collective investment schemes have a highly concentrated market structure with five managers controlling 90% of market. Bapepam-LK is planning to increase the minimum capital to weed out the smaller participants who are not contributing to the growth of the industry. Greater compliance by asset management firms is expected upon the introduction of the new rule.
53. To enhance the performance of the contractual savings industry, pension funds need to
21 Straight Through Processing (STP) enables the entire trade process for capital markets and payment transactions to be conducted electronically without the need for re-keying or manual intervention, subject to legal and regulatory restrictions.
18 be allowed to invest in a wider range of domestic instruments. Similarly, market competition could be increased by allowing the participation of more fund mangers who are appropriately qualified. The implementation of the new social security system for pension, old age savings, and death benefit schemes needs to be expedited through the submission of a white paper that was developed with ADB TA.22
54. Mutual exchange structure. The implementation of the merger agreement between the Jakarta Stock Exchange and Surabaya Stock Exchange, which were merged in September 2007, has been effectively implemented. The Indonesia Stock Exchange has upgraded to a new trading system in March 2009. The new trading platform replaces the two systems previously used at the Jakarta and Surabaya stock exchanges. Diversification of ownership of the merged exchange will however require amendments to the Capital Market Law. A comprehensive review of all self-regulatory organization activities and detailed measures for market development and surveillance also needs to be carried out, including enabling the operation of an alternative trading system and electronic communication network (non-exchange trading venues) through the amendments to the Capital Market Law.
3. Improve Market Surveillance and Investor Protection
55. Regulatory structure. A strong Bapepam-LK is needed for a coherent policy and regulatory approach to the capital markets and the nonbank financial sector. However, Bapepam-LK is still part of the MOF and does not have the same autonomy or human resource capacity as Bank Indonesia. The Government recognizes the importance of the International Organization of Securities Commissions (IOSCO) principles for investor protection as the basis for the development of modern capital markets. In line with these principles, the Government is committed to enhancing Bapepam-LK’s operational and financial autonomy through appropriate legal and regulatory measures. The initial focus was to establish OJK as an independent body by 2010 to supervise capital markets, nonbank financial institutions, and banks through an oversight board. As originally proposed, the OJK law was to be drafted and submitted to the President of Indonesia by 30 June 2009. However, the global financial crisis has prompted a reassessment of financial regulatory systems worldwide, including in Indonesia. The global crisis has led national authorities—together with regional and global financial institutions—to reexamine approaches to financial regulation and supervisory oversight. The combination of regulators under one structure has faced major challenges, for example in the United Kingdom. The crisis continues to reshape the global financial architecture, and regulatory overhauls are under discussion worldwide to address apparent weaknesses and gaps.
56. The region’s authorities need to strengthen their national regulatory and supervisory frameworks, in line with higher regulatory standards emanating from global reforms. Regardless of the institutional arrangements for supervision—whether unitary, “twin-peaks,” or multiple supervisors—legal authority, information sharing, and effective coordination remain essential for effective crisis management. Institutional frameworks for financial regulation come in many forms, depending on the different structures of financial sectors and the stage of market development in individual economies. Little evidence has been found that one regulatory structure is universally better than the alternatives. Whether a country follows an approach of a single unified supervisor or several supervisors may not be as critical as having a supervisory structure with clear objectives and supervisors with the authority and legal power to regulate and take effective action, especially in resolving financial distress in a coordinated manner.
22 ADB. 2002. Technical Assistance to the Republic of Indonesia for Financial Governance and Social Security. Manila.
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Rather than rushing through structural reforms, it is appropriate for Indonesia to conduct a detailed review to decide on a regulatory structure that is more integrated and efficient, while reducing externalities and enhancing financial stability to minimize systemic risks. In parallel, Bapepam-LK must have sufficient autonomy and independence for efficient regulation of the capital market and nonbank financial sector.
57. An amendment to the Capital Market Law is required to give Bapepam-LK staff legal immunity when carrying out their supervisory functions. Revisions to the Capital Market, Pension, and Insurance Laws also need to be accelerated to bring them in compliance with IOSCO principles for securities, International Association of Insurance Supervisors core principles, and OECD guidelines for occupational pensions.
58. Regulation and supervision. The legal and regulatory environment for mutual funds needs to be improved. The laws are an amalgam of US regulations for corporate funds (which do not exist in Indonesia) with a few references to contractual funds (i.e., all mutual funds in Indonesia). The sections of the Capital Market Law that pertain to mutual funds and the associated regulations need to be amended to improve investor confidence and to develop the industry. Guidelines on asset valuation and disclosure rules need to be issued with the prospectus for each investment fund. Bapepam-LK’s investigation procedures need to be streamlined and the flow of information improved to allow administrative sanctions to be imposed more easily. For suspected criminal offenses, better coordination and cooperation with the judicial branch is needed. To strengthen its internal governance and accountability, Bapepam-LK needs to establish an internal compliance bureau with a code of conduct for officials and staff.
59. Investor protection. Indonesia does not have an investor protection fund to protect investors if a broker defaults. The rules require securities firms to take out insurance to cover this eventuality, but such insurance is not available and the rule has not been enforced. This lack of insurance exposes investors to significant risk and is likely to deter investors of all sizes from participating in the market. Such funds are typically built up by contributions from brokers.
60. International cooperation. Bapepam-LK has entered into bilateral arrangements with domestic and foreign regulators, and has taken steps to seek membership of the IOSCO multilateral memorandum of understanding. However, it is prevented from joining because of a lack of legal clarity with regard to its powers to (i) share confidential data with other regulators, (ii) access bank records and identify beneficial ownership of shares, and (iii) guarantee confidentiality of requests from foreign regulators. Bapepam-LK needs to initiate the necessary steps to promote regional cooperation by developing action plans to implement the IOSCO memo. Regional integration can facilitate domestic capital market development by providing the liquidity, scale, and capacity to compete globally and manage volatility more effectively (para. 35). Bilateral MOUs with foreign capital markets regulators will help strengthen information sharing.
61. Risk-based supervision in contractual savings industry and minimum capital requirements. In 2000, Indonesia became the first country in Asia to implement modern risk- based capital requirements for life and general insurers. The Bureau of Insurance has been moving toward risk-based supervision, although more rapid progress is needed. Implementation of risk-based capital regulations need to be reviewed and corporate governance standards enforced. The pension industry also needs to move toward risk-based supervision. To strengthen and consolidate the insurance sector, an increase in the minimum capital
20 requirement levels for both non-life and life insurers from the current Rp40 billion has been considered in line with international standards.
4. Improve Governance and Human Resource Capacity
62. Strengthen financial sector risk management through coordination among regulators. If there is more than one regulator, each needs to have clear and precise objectives, be subject to extensive disclosure requirements, and be publicly accountable. Adequate arrangements, preferably documented, are also needed to ensure the regulators cooperate when necessary, and that they have powers to exchange relevant information. Incentives for regulatory arbitrage should be recognized and minimized, and regulatory gaps should be spotted and filled at an early stage. Formal coordination between Bank Indonesia, the MOF, and the Deposit Insurance Institution needs to be clearly outlined to prevent potential risks to the system’s stability. A financial sector assessment program to allow for comprehensive and up-to- date diagnosis of financial sector vulnerabilities is overdue.
63. Anti-Money-Laundering Regime. While considerable progress has been made in strengthening the anti-money-laundering regime for the banking sector, the nonbank financial sector lags in terms of the effectiveness of regulations and supervision, as well as in the capacity of institutions to comply with the law. To reduce the risk of nonbank financial institutions being used for money laundering, regulations, supervision (capacity, enforcement powers, and sanctions), and capacity for compliance will need to be strengthened to achieve parity with the banking sector.
64. Institutional Capacity. Bapepam-LK will require support over the medium term for it to become an effective regulator. Governance of regulatory agencies and market institutions requires staff with graduate level education in actuarial science and finance, as well as experience in regulatory practices and market surveillance in developed markets. Acquiring these skills is a precondition for success, but the Government will have to commit adequate resources over the medium and long term if technical and regulatory excellence is to be achieved.
C. Lessons
65. ADB’s financial sector interventions in Indonesia. In addition to subprogram 1 under the CMDPC, ADB has undertaken four major financial sector operations in Indonesia addressing banking, capital markets, pensions, and insurance over the past two decades. The thrust of financial sector reforms over this period moved from deregulation of the banking sector and capital market to implementation of a comprehensive set of reforms aimed at strengthening potential safeguards while encouraging market forces and market efficiency. The rapid growth that occurred after deregulation and the subsequent problems in the banking sector highlighted inadequacies in the legal, regulatory, and supervisory frameworks, while underpinning the importance of a long-term approach to strengthening capacity.
66. Continuing support through technical assistance. ADB TA (footnote 7) focused on strengthening Bapepam-LK. It supported the preparation of a nonbank financial sector action plan, an assessment of Indonesian standards in meeting IOSCO principles for capital market regulation, and an evaluation of training needs within Bapepam-LK. The TA has also supported the development of the bond market, improvements to the research and surveillance functions of Bapepam-LK, and the preparation of regulations and guidelines for Islamic financial products. Follow-up TA support (footnote 2) for implementation of reforms and policy actions under the
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Program was attached to subprogram 1. The TA is being used to develop the capacity within Bapepam-LK.
67. Lessons learned. Broad-based reforms require long-term institutional development and must be fully aligned with the Government’s national and sector development plans. The CMDPC comprising subprogram 1 and subprogram 2 was developed on this basis to be implemented from 2006 to 2010. The program cluster is considered a useful approach in this regard, as it combines a long-term view covering a wide range of policy and institutional reforms with the flexibility to adjust to changing circumstances. Policy actions initiated under subprogram 1 will be maintained and pursued to completion through proposed follow-up actions under subprogram 2. It allows the gradual introduction of critical components in the sector, including a comprehensive legal framework and an action plan. Program clusters can also enable benchmarks to be established and unify policy makers who advocate reforms. The program completion report 23 for the Financial Governance and Social Security Reform Program recommended a framework based on single-tranche programs within a program loan cluster to provide more flexibility while focusing on achievable, upfront outcomes. Much of the success of such an approach will depend on the commitment by stakeholders. The Indonesia country assistance program evaluation24 noted that the ADB financial sector projects and programs have generally performed well.
V. THE PROPOSED PROGRAM
68. The accomplishments since subprogram 1 (Table 3) have exceeded some of the performance indicators originally envisaged in the design and monitoring framework (DMF) for the CMDPC and fully justify subprogram 2. The DMF has been revised to reflect these achievements (Appendix 1). The indicative policy actions adopted for subprogram 2 while processing subprogram 1 in 2007 and their links to the proposed subprogram 2 is in Appendix 4.
Table 3: Accomplishments since Subprogram 1 Indicators 2006 July 2009 Increase (%) Market capitalization (Rp trillion)a 1,249.10 1,875.04 50 Investors a 215,025 339,352 58 (Dec 07) Listed companies a 344 404 18 Mutual fund unit holders 197,380 351,489 78 Foreign mutual fund unit holders 5,611 6,003 7 Assets of pension funds (Rp billion) a 74,806 86,007 15 Trading cost (basis points) 72 52.98 26 (reduction) (i) New products introduced such as Asset Backed Exchange Traded Fund, sharia-compliant securities (ii) Enhanced trading system infrastructure in stock exchange (iii) Setting up of Capital Market Institute to lead to improved quality of industry professionals (iv) Enhanced Institutional Capacity in Bapepam-LK (v) Infrastructure Financing Company to be set up in 2009 to provide long-term financing a Exceeded targets set under the design and monitoring framework during subprogram 1. Source: Bapepam-LK.
23 ADB. 2006. Completion Report on the Financial Governance and Social Security Reform Program in Indonesia. Manila. 24 ADB. 2005. Country Assistance Program Evaluation for Indonesia. Manila.
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A. Program Design
69. The Government recognizes that the Indonesian capital market needs to be enhanced by strengthening the institutions and the regulatory policy framework. In 2007, subprogram 1 identified a strong need to strengthen transparency and information disclosure, which are essential to building confidence in capital markets and institutions, facilitating regulatory oversight, and promoting price discovery and market liquidity. Both supply and demand sides of financial markets needed to be addressed. On the supply side, a sequence of measures was needed to deepen government bond markets and develop the short-term and interbank money markets as the essential building block for the development of corporate bond markets. On the demand side, broadening the investor base through the promotion of institutional investors, such as contractual savings and collective investor schemes, is required. To enable markets to function with sufficient speed, efficiency, and accountability, the underlying micro-structure for trading securities needed to be strengthened. The operational and financial autonomy of regulatory and supervisory authorities also needed to be strengthened with a view to ensuring investor protection. As a result, a policy reform program initiated with two subprograms was proposed to begin addressing these issues from January 2006 to August 2009. The initial success of the reforms under subprogram 1 has fully justified the development of subprogram 2. While subprogram 1 covered January 2006 to September 2007, subprogram 2 covers October 2007 to August 2009.
B. Impact and Outcome
70. The impact of subprogram 2 as part of the overall impact of CMDPC will be greater financial sector diversification and resilience. The CMDPC has been embedded in the Government's medium-term reform agenda. The outcome of the CMDPC is greater contribution by the capital market to domestic financing. Towards this end, CMDPC will support accelerated capital market growth to enable more diversification of markets combined with stronger regulatory and supervisory capacity to ensure resilience of the financial sector that will promote economic development. The CMDPC is expected to lead to an increase in the nonbank financial sector’s share of total financial assets.
C. Policy Framework and Accomplished Actions
71. The policy measures supported by the CMDPC include a set of sector reforms to promote financial diversification by enhancing the growth and development of capital markets. The reform agenda is structured around the following policy outcomes, which form the basis of the four components of the CMDPC: (i) enhancing information disclosure and price discovery, (ii) promoting deeper and more liquid financial markets, (iii) improving market surveillance and investor protection, and (iv) strengthening governance and human resource capacity.
1. Enhancing Information Disclosure and Improving Price Discovery
72. Bapepam-LK has issued rules requiring prompt disclosure of secondary trading in bonds under subprogram 1, while requiring issuers of bonds to have an annual rating of outstanding securities. With this disclosure, the market valuation of fixed-income instruments can be achieved. To this end, Bapepam-LK issued regulations to establish a bond pricing agency (BPA) in the private sector. Under subprogram 2, the BPA has become operational as an independent market-neutral entity to provide fair valuation of fixed-income instruments.
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Moreover, all issuers and public companies were required under subprogram 1 to provide additional information on corporate governance as part of their annual reports. To improve market transparency, Bapepam-LK has issued directives under subprogram 2 for prompt public disclosure of changes in beneficial ownership beyond 5% in the shareholding of any listed company.
2. Promoting Deeper and More Liquid Financial Markets
73. The supply and demand sides are important, as is the underlying micro-structure, for trading of securities. On the supply side, the Government has adopted a series of measures under subprogram 1 and 2 to develop deeper and more liquid securities markets, most importantly at the short end of the market. Benchmark yields for government bonds are being developed by concentrating the issuance of government bonds at the selected maturities of 5, 7, 10, 15, 20, and 30 years. This has been improved further under subprogram 2 where the DMO directorate general issues regular updates to the annual auction calendar to provide market participants with more clarity on issuance expectations. The primary dealer system has been established with market making responsibilities in government debt securities to ensure two-way quotes and to support the development of its secondary market. To develop the short-term government debt market, treasury bills of 9–12 months maturity have been issued. The Government will gradually progress issuance of treasury bills down to 1 month maturity with the longer-term objective of replacing short-term bills issued by Bank Indonesia. The DMO issued its first 3-month bills in February 2009.
74. Secondary market liquidity has been enhanced under subprogram 2 through better coordination between Bapepam-LK and Bank Indonesia. In coordination with Bapepam-LK, the DMO directorate general, the tax directorate general, and market participants, Bank Indonesia has initiated a comprehensive review of the legal and business requirements for adoption of the General Master Repurchase (Repo) Agreement. It is also developing a centralized borrowing and lending program for government bonds. The monitoring of the operations of the primary dealer has improved under subprogram 2 to ensure that the market making commitments are being carried out and obligations to provide the two-way quotes are being met. Steps have been initiated to improve the clearing and settlement infrastructure under subprogram 2, moving towards continuous settlement. Revisions in rules and regulations on short selling and margin trading were issued in June 2008 supported under subprogram 2. Infrastructure development has been facilitated through the amendment of Presidential Decree 61/1998 in 2009 to allow the establishment of finance companies to provide long-term financing for infrastructure, thus deepening the debt market.
75. On the supply side, government bonds have been issued in small denominations in a successful appeal to the retail public. In parallel, rules were issued under subprogram 1 to facilitate the issuance of new products, such as municipal bonds, sharia-based instruments, exchange traded funds, and securitization of asset-backed receivables such as mortgages. Other than municipal bonds, these new products were offered during subprogram 2. Steps have been initiated under subprogram 2 to introduce hedging instruments, such as stock options and index-based futures. The development of the housing finance industry has been another priority with amendments to the Presidential Decree No.19 of 2005 to enable PT Sarana Multigriya Finansial, the secondary mortgage finance institution, to lend up to 15 years to develop the critical mass of primary mortgage receivables. This measure is expected to eventually lead to the development of a secondary market for securitization of mortgage receivables. Other new products, such as sharia-compliant government bonds (sukuks) and Asset-Backed Exchange Traded Fund, were developed and issued during subprogram 2.
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76. The infrastructure—or micro-structure—for market trading is being enhanced. Screen- based trading has been introduced countrywide. The merger of the two stock exchanges in Jakarta supported under subprogram 1 is supporting further developments in this area. This is expected to lead to better governance of the stock exchange, while broadening ownership and integrating offerings of debt and equity securities. The implementation of the merger agreement of the two exchanges was completed under subprogram 2, while the proposal for demutualization of the merged exchange will be initiated through the proposed amendments to the Capital Market Law. Government regulation 25/2009 (March) provides for same tax treatment for sharia-based products as conventional transactions. Distortions and preferential treatment for mutual funds on income derived from fixed-income securities have been removed. Moreover, to promote more listing and float in the securities market, tax incentives have been provided, effective January 2008, through the issuance of a decree. Bapepam-LK is progressively adopting international financial reporting standards.
3. Improving Market Surveillance and Investor Protection
77. Subprogram 1 supported the development and submission to the Minister of Finance of a proposal for an appropriate regulatory structure for the capital markets and the nonbank financial institutions supervisory agency. This was to be independent of the MOF, but reporting to the minister, with powers to recruit staff outside the civil service code. To establish OJK as an independent body to supervise capital markets, nonbank financial institutions, and banks with an oversight board, a draft OJK law was being developed for submission to the President of Indonesia by 30 June 2009. Given the implications of the global financial crisis and the need for a more detailed study on an appropriate regulatory structure (paras. 55–56), subprogram 2 supported the establishment of a task force in August 2009, comprising senior officials of Bapepam-LK and Bank Indonesia. This review will consider different options on regulatory structures, including separating the monetary policy and supervisory functions in Bank Indonesia. The study is expected to be completed by the end of 2009. Irrespective of the structure that is adopted, the aim will be to empower Bapepam-LK with more autonomy and independence by separating it from the MOF (but reporting to the minister of finance) in early 2010. Amendments to the three sector laws (capital markets, pensions, and insurance), which Parliament was to consider after the OJK, were drafted during subprogram 2 and made available for public comments. Submission to the President is targeted by the end of April 2010. Drafts will allow for greater compliance with international best practices and principles (IOSCO), OECD, International Association Insurance Supervisors, and Bank for International Settlements. All draft sector laws will (i) provide indemnity for staff for official acts done in good faith, (ii) require better governance by market participants, and (iii) strengthen enforcement powers. The proposed measures for greater operational and financial autonomy will be accompanied by enhanced accountability. The follow-up actions, including the submission of the above sector laws to the President and then to Parliament will be monitored through the post-program monitoring framework (para. 83).
78. Risk-based supervision has been extended under subprogram 2 to all institutions in the capital markets and the contractual savings industries. Subprogram 2 supported the issuance of rules in 2008 requiring an increase in minimum equity for insurance companies from Rp40 billion to Rp100 billion, and for reinsurance companies from Rp100 billion to Rp200 billion during a transition period from 2010 to 2014. Based on the feasibility study carried out under subprogram 1, an implementation plan was developed under subprogram 2 for establishing an investor protection fund by 2010-2012 in consultation with the brokerages.
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79. Under subprogram 2, IDX has also entered into bilateral MOUs (drafted by Indonesia) with five other participating ASEAN exchanges as part of regional commitment to set up an ASEAN trading board, which will involve 30 stocks from each participating stock exchange implemented through a common exchange gateway.
4. Improving Governance and Human Resource Capacity
80. The Government has initiated the Financial Sector Assessment Program evaluation (with the International Monetary Fund and World Bank) to allow for comprehensive and up-to- date diagnosis of financial sector vulnerabilities. This was initiated during subprogram 2.
81. Under subprogram 2, an awareness raising and training program for regulated entities in the nonbank financial sector was conducted to strengthen their capacity to comply with anti- money-laundering responsibilities. "Know-your-customer" rules were strengthened for nonbank financial institutions under subprogram 1, while the capacity within nonbank financial institutions is further strengthened under subprogram 2 to improve compliance with anti-money-laundering regulations.
82. Efforts to strengthen the human resources in the capital markets that was initiated under subprogram 1 was further broadened under subprogram 2 with Bapepam-LK studying a number of options including developing and adopting a plan of collaboration with universities in Indonesia to serve the research needs of the capital markets and the contractual savings industries. An important milestone was the MOU signed under subprogram 2 in 2009 to initiate the Capital Markets Institute cooperatively by IDX, KPEI, KSEI, University of Indonesia, and Bapepam-LK to provide a focus for undergraduate, graduate, and professional training to develop the capital markets. Bapepam-LK has also adopted a medium-term plan to develop regulatory information and the research capability at Bapepam-LK to meet current and future needs. In addition to the ADB TA under the Program, the Government is committed to allocating through its normal budgetary process $18 million during 2008–2012 to meet capacity building needs in the area of capital markets and nonbank financial institutions (e.g., support for secondments, specialized recruitment and advanced training, specialized training, and support through academic institutions) to move towards achieving technical regulatory excellence. With well-trained regulators, regulatory implementation and effectiveness will be substantially enhanced.
83. Post-program monitoring framework. The Government has recognized that the capital market reform program would need to extend beyond the two subprograms under the CMDPC. As such, a post-program monitoring framework for follow-up policy actions for September 2009–June 2011 has been developed in consultation with various agencies (Appendix 4). This policy matrix will eventually be used as the basis for the follow-up program proposed in the 2011–2012 pipeline. A completion report for evaluating the accomplishments under the CMDPC is also proposed in 2010.
Table 4: Post-Program Monitoring Framework for Follow-Up Policy Measures NO. Actions Completed under Subprogram 2 Follow-Up Policy Measures (September 2009–June 2011) Promoting deeper and more liquid capital markets 1. Undertook a comprehensive review Formulate and finalize a comprehensive repurchase agreement of the legal and business addressing requirements for adoption of the (i) taxation, risk exposure, dispute minimizing, etc; GMRA (ii) compatibility issues of the current MRA to GMRA utilizing international best practices, as appropriate, the Indonesian
26
NO. Actions Completed under Subprogram 2 Follow-Up Policy Measures (September 2009–June 2011) annexes. Bank Indonesia will (i) advocate the adoption of the finalized repurchase agreement by banks for all repurchase agreement transactions, and (ii) consider the finalized repurchase agreement for its repurchase agreement transactions. 2. Increased the range of treasury bill Progressively replace SBIs with treasury bills (with increased range of maturities on offer to develop a maturities) to promote a liquid short-term government securities short-term yield curve market 3. Bapepam-LK submitted case for Bapepam-LK to coordinate with Tax directorate general to allow for full application of (exempt-exempt- amendment of MOF decree to allow exemptions to take effect by 31 taxable) tax treatment for pension December 2009 funds on investment. Improving market surveillance and market protection 4. Joint task force set up comprising Study to be completed by December 2009 deciding appropriate senior officials from Bank Indonesia structure. Enabling provisions on recommended structure to be and Bapepam-LK and study submitted to competent authority for approval in 2010. Bapepam-LK initiated on alternative options for empowered with financial autonomy and strengthened powers by appropriate integrated regulator December 2010 structure for the financial sector 5. Draft amendments to the capital Draft amendments of three sector laws to be submitted to President by market, pension and insurance April 2010. To be submitted for Parliamentary consideration later in laws completed 2010 6. Development of Capital Market Capital Market Master Plan (2010–2014) completed and adopted by Master Plan (2010–2014) initiated December 2009. 7. Established a special task force to Bapepam-LK to join Schedule A of IOSCO MMOU, and develop and assess obstacles to joining implement related action plan Schedule A of IOSCO MMOU. 8. IDX to enter into bilateral MOUs Bapepam-LK to (i) circulate code of conduct of its SROs and capital with five other participating ASEAN market participants to the other securities regulators in ACMF to allow exchanges to set up ASEAN countries to better harmonize codes, (ii) work towards achieving trading ASEAN Plus standards, (iii) incorporate regional integration issues in its National Capital Market Master Plan, and (iv) develop dispute resolution mechanisms and circulate to ACMF members. 9. Bapepam-LK and IDX to develop Bapepam-LK in conjunction with SROs (including IDX) to implement an implementation plan for a the plan for a securities market investor protection fund. securities market investor protection fund. 10. The BPA is fully operational Bapepam-LK to issue rules and guidelines for fund managers to utilize the independent valuation provided by licensed BPA Strengthening governance and human resource capacity 11. CMI initiated cooperatively by IDX, IDX, KPEI, KSEI, UI, and Bapepam-LK to fully develop a self-managed KPEI, KSEI, UI, and Bapepam-LK CMI as a focus for capital markets education in Indonesia. 12. MOF to commit incremental MOF to continue to fund the needed staff development of regulatory expenditures for capacity staff ACMF = ASEAN Capital Markets Forum; ASEAN = Association of Southeast Asian Nations; BPA = bond pricing agency; CMI = Capital Markets Institute; GMRA = General Master Repurchase Agreement; IOSCO = International Organization of Securities Commission; KPEI = PT Kliring Penjamin Efek Indonesia (Indonesia Clearing and Guarantee Corporation); KSEI = Kustodian Sentral Securities Depository; SRO = self regulatory organization; UI = University of Indonesia Source: Asian Development Bank.
D. Important Features
84. The CMDPC has a number of distinct and innovative features. First, the Government is strongly committed to the development of capital markets through the CMMP and the FSPP. These initiatives represent a combination of economic, business, legal, and regulatory factors designed to enhance the role of Indonesia's capital market in contributing to financial sector
27 resilience and as an engine of accelerated economic growth. Second, the CMDPC supports qualitative changes in reform processes to ensure effective implementation for results-based outcomes. CMDPC focuses on outcomes and allows for greater flexibility in actions necessary to achieve compliance. Third, it is predicated on the need for a policy and institutional response to significant market developments since the completion of the subprogram 1. Fourth, the CMDPC has helped establish a program coordination committee that will be responsible for implementing the action plan adopted for the CMMP and the FSPP. Fifth, it includes an indicative policy reform agenda for the follow-up program in 2011–2012 that builds upon subprogram 1 and 2 reforms, thus providing for flexibility in developing future programs.
E. Financing Plan
85. The gross financing needs of the Government have increased from $18.2 billion in 2008 to $25.8 billion in 2009 based on the revised 2009 budget that included the fiscal stimulus to respond to the global financial crisis. These growing financing needs reflect higher levels of domestic and foreign debt principal repayments and changes to the 2009 budget. The revised 2009 budget projects a lower increase in revenues because of the economic slowdown, and the need for additional spending to stimulate the economy in 2009 and to fund poverty reduction programs. The revised budget protects social sector spending, particularly education and the flagship community-based poverty reduction program, to provide a cushion for adversely affected households. Overall, the Government is budgeting for additional spending and countercyclical spending of up to Rp73.2 trillion in 2009. Its financing plan (Table 5) indicates that gross financing requirements of $25.8 billion will be met from the following sources: (i) $13.8 billion from the issuance of domestic and international bond bonds, (ii) $5.4 billion from the banking system and excess financing from 2008, and (iii) $6.6 billion from official development assistance and project lending. The Government will draw down the Public Expenditure Support Facility (footnote 4) and related support from other development partners when it cannot meet its financing targets from the markets within market access conditions specified in the Government’s financing plan and other conditions set out in the related loan agreement.
Table 5: Projected Financing Requirements of the Government of Indonesia, 2009 ($ billion) Proposed Financing Mix Amount Gross Financing Requirements 25.77 Less Amortization 12.15
Net Financing Requirement 13.62 Programmed Gross External Borrowings 6.60 of which: ADB’s Proposed Loan Pipeline 0.75 Development Policy Support Program 0.20 Indonesia Infrastructure Financing Facility 0.10 Capital Market Development (Subprogram 2) 0.30 National Community Empowerment Project 0.07 Metropolitan Sanitation Project 0.05 Java Bali Distribution Performance Improvement 0.04 Other Funding Agencies and Commercial Borrowings 5.85 ADB = Asian Development Bank. Note: Exchange rate: $1 = Rp 10,500. Sources: Ministry of Finance and ADB estimates.
86. The proposed single-tranche loan for subprogram 2 of $300 million will help the Government meet its financing needs. The loan will be provided from ADB’s ordinary capital
28 resources. It will have a 15-year term, including a grace period of 3 years, an interest rate determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility, and a commitment charge of 0.15% per year.25
87. The size of the proposed loan is based on (i) the economic importance of the financial sector, (ii) the significance of the proposed reforms over the medium term, (iii) the CMDPC’s development impact, and (iv) the Government’s overall financing needs for the fiscal stimulus to meet the international credit crisis. Market forces need an effective and transparent regulatory framework. In the absence of timely reforms, the financial sector will continue to be ineffective in intermediating resources for productive investment, financial institutions will remain vulnerable to systemic risks, and investors will be vulnerable to fraud and misconduct.
F. Implementation Arrangements
1. Program Management
88. Bapepam-LK has been the Executing Agency for subprogram 2 and has monitored and facilitated the implementation of the agreed upon reform actions to ensure that they have been carried out in a timely manner. The implementing agencies have been Bank Indonesia; Bapepam-LK, Debt Management Office (DMO), the Directorate of Taxes (DOT), all three under the Ministry of Finance; and the Indonesian Stock Exchange (IDX). Bapepam-LK established a program coordination committee chaired by the Bapepam-LK with representatives from Bank Indonesia, Bappenas (National Development Planning Agency), DMO, DOT, and IDX. The committee has been responsible for coordinating the implementation program actions and sustaining them. The committee has overseen the implementation of the policy actions detailed in the policy letter and the policy matrix, and has provided guidance and direction to Bapepam- LK, the implementing agencies, and other line agencies of the Borrower.
2. Implementation Period
89. The implementation period for subprogram 2 has been from October 2007 to August 2009. The Government has completed all actions in the policy matrix for subprogram 2. In addition, a post-program monitoring framework has been adopted by the Government in partnership with ADB for September 2009–June 2011.
3. Procurement and Disbursement
90. The loan proceeds will be used to finance the full foreign exchange cost (excluding local duties and taxes) of items produced and procured in ADB member countries, excluding ineligible items, and imports financed by other bilateral and multilateral sources. In accordance with the provisions of ADB’s Simplification of Disbursement Procedures and Related Requirements for Program Loans (1998), the reimbursement procedure will be used to disburse the loan proceeds based on certification by the Borrower. No supporting import documentation will be required if during each year the value of Indonesia’s total imports minus imports from nonmember countries, ineligible imports, and imports financed under other official development assistance is equal to or greater than the amount of the loan expected to be disbursed during such year. The Government will certify its compliance with this formula with each withdrawal
25 There will be no commitment charge for the single-tranche loan if it is declared effective and disbursed within 60 days after the signing of the Loan Agreement.
29 request. Otherwise, import documentation under existing procedures will be required. ADB reserves the right to audit the use of the loan proceeds and to verify the accuracy of the Government’s certification.
4. Anticorruption and Fiduciary Assessment
91. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the Government and Bapepam-LK. Consistent with its commitment to good governance, accountability, and transparency, ADB reserves the right to investigate, directly or through its agents, any alleged corrupt, fraudulent, collusive, or coercive practices relating to the Project. To support these efforts, relevant provisions of ADB’s Anticorruption Policy are included in the loan regulations and the bidding documents for the Project. In particular, all contracts financed by ADB in connection with the Project shall include provisions specifying the right of ADB to audit and examine the records and accounts of the Executing Agency and all contractors, suppliers, consultants, and other service providers as they relate to the Project.
92. The proposed subprogram 2 directly addresses anticorruption issues in the financial sector through its core focus on strengthening protection for investors against fraud and misrepresentation. This is part of a broader Government agenda to fight corruption and improve its public financial management systems. Presidential Decree 80/2003 sets out the basic principles of procurement: transparency, open and fair competition, economy, and efficiency. Several state auxiliary bodies have been established with mandates to fight corruption: the Commission for Eradication of Corruption, the National Ombudsman Commission, the National Law Commission, and the Commission for the Eradication of Money Laundering. 26 The Corruption Eradication Commission has effectively prosecuted some high-ranking officials. Further, the DPSP cluster (footnotes 8 and 9) had a core focus on improving governance and anticorruption initiatives. It promotes transparency in public finance management and aims to strengthen the independent oversight mechanisms by improving the auditing framework. The Government has reorganized MOF, separating the budget and treasury functions. It has also initiated steps to increase efficiency and transparency, and to reduce corruption in public finance management. The Government emphasizes strengthening internal control systems and overall public finance management, with support from the World Bank.27
93. An update of the country’s financial management systems assessment also draws on recent economic and sector work undertaken by the World Bank and ADB.28 It is also anchored on the results of a public expenditure and financial assessment concluded in June 2008.29 Based on this assessment, the fiduciary arrangements proposed for subprogram 2 remain acceptable. Since 1997, substantial progress has been made in improving the regulatory framework for improved public financial management, under three laws (The Law on State Finance, The State Treasury Law, and the State Audit Law), and the other complementary laws on planning and procurement, and related implementing regulations. The Fiscal Policy Office within MOF has a mandate to undertake macro-fiscal projections and analysis. Budget documentation and disclosures to the public have improved. A fiscal risk statement is now included in the annual budget documents, making Indonesia one of the pioneers in fiscal risk analysis among emerging market economies. A more recent focus has been on improving
26 ADB has been closely involved in the establishment and strengthening of the anti-money-laundering regime in Indonesia through TA support as well as policy-based loans. 27 The Government Financial Management and Revenue Administration Project was approved in December 2004. 28 ADB. 2007. Sector Report on Accountability and Audit in Indonesia. Manila (produced under TA-4473 INO: Support for Implementation of Program Loan). 29 World Bank. 2008. Public Expenditure and Financial Assessment. Report No. 42098 ID. Washington, DC (June).
30 budget execution to avoid underspending as the allocation of funds and the implementation of the budget remain serious constraints. The 2007 government cash management regulations contributed to consolidating government bank accounts, and also improved cash management by including off-budget accounts in the single treasury account. Major public financial management reforms are underway in Indonesia including medium-term expenditure framework, program, and performance budgeting; and the modernization of the treasury system, including a financial management information system. Other complementary measures include unification of the planning and budgeting processes, revised chart of accounts and budget classification, new treasury processes, and improved auditing.
5. Accounting, Auditing, and Reporting
94. ADB retains the right to audit the use of the loan proceeds and to verify the accuracy of the Government’s certification for the withdrawal applications. Before withdrawal, the Government will nominate an account (the deposit account) at Bank Indonesia to receive the loan proceeds. The account will be managed, operated, and liquidated in accordance with terms satisfactory to ADB. Bapepam-LK will submit progress reports on policy and institutional reform implementation to the program coordination committee and ADB. These will be submitted in such form and in such detail as ADB may request, and should include (i) progress made and problems encountered during the period in review, (ii) steps taken or proposed to be taken to remedy problems encountered, (iii) proposed detailed activities for program implementation, and (iv) expected progress based on (ii) and (iii) above.
6. Counterpart Funds
95. Counterpart funds generated by subprogram 2 will be used by the Government, under arrangements satisfactory to ADB, to meet program expenditures and associated costs of reform and additional budgetary allocation for the fiscal stimulus program to address the international credit crisis.
7. Monitoring and Review
96. ADB will, in cooperation with MOF and Bapepam-LK, carry out periodic reviews of progress and outcomes of subprogram 2 after it is completed. The Government will keep ADB informed of the outcome of policy discussions with other multilateral and bilateral agencies that have implications for program implementation, and will provide ADB with the opportunity to comment on any resulting policy proposals. ADB, in collaboration with MOF and Bapepam-LK, will review program performance about 6 months after loan effectiveness to review the outcome of subprogram 2. In addition to the progress reports, MOF and Bapepam-LK will submit within 30 days of the subprogram 2 review by ADB a report that will evaluate the implementation of the policy reform measures under subprogram 2. To enable the processing of the program envisaged in 2011–2012, this report will also assess the impact on the sector, describe lessons identified during the program period, and outline reforms and assistance needed for the development of the sector.
VI. TECHNICAL ASSISTANCE
97. A TA is being processed separately to support the continuation of the reforms beyond the CMDPC, including the policy measures included in the post-program monitoring framework. The TA will lead to a deeper and more resilient capital market, and better supervision with improved regulatory resources and capacity. Through the proposed technical support, overall
31 governance standards and investor protection will be improved. To attain these objectives, the key activities targeted are (i) supporting regulatory reforms identified following the Financial Sector Assessment Program; (ii) supporting implementation of CMMP (2010–2014); (iii) strengthening the enforcement resource capability of Bapepam-LK; (iv) further benchmarking of the regulatory framework for harmonization of standards and regional cooperation; (v) establishing an investor protection fund for the securities market; (vi) developing a structured approach to fully implement capacity building of human resources of Bapepam-LK, including the establishment of the Capital Markets Institute; (vii) developing a comprehensive capital markets database for public information services and the promotion of market transparency; (viii) formulating a comprehensive compliance framework for capital market intermediaries; (ix) supporting the development of new products such as mortgage credit insurance and other risk mitigation products; and (x) supporting insurance industry consolidation. These activities are essential to promote capital market resilience, growth, and sustainability.
VII. PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS
A. Benefits
98. The CMDPC is providing a policy framework that encourages financial innovation in terms of new capital market instruments, longer tenors, and new kinds of intermediation—all critical for infrastructure financing. It will enhance information disclosure and facilitate price discovery, thus improving the efficiency of financial markets in pricing risk. This will help to create deeper and more liquid capital markets. In particular, subprogram 2 will also promote stronger intermediaries that are better able to mobilize and allocate resources and risks. Better market surveillance and investor protection will promote stability and resilience, and are essential for capital market development. To maintain the momentum in reforms, the Government proposes to have in place the CMMP for 2010–2014, developed through ADB TA, by end 2009 and implemented through a TA that is being separately processed. Together with broader economic reforms in Indonesia, the reform of capital markets will contribute to financial sector stability, productivity growth, and employment generation.
B. Social and Environmental Safeguards
99. Subprogram 2 did not entail any involuntary resettlement or have a negative impact on indigenous people or the environment. It is classified as category C for involuntary resettlement, the impact on indigenous people, and the impact on the environment. Subprogram 2 was a general intervention aimed at supporting sustainable economic growth and is expected to have an indirect positive effect on poverty reduction. The summary poverty and social impact analysis is in Appendix 6; the environmental impact analysis is in Appendix 7.
C. Risks
100. The assumptions underlying subprogram 2 included the following: (i) The economy will withstand the direct adverse effects of the ongoing global financial crisis, both the decline in economic activity and the distortions created in Indonesian financial markets. (ii) The needed political will and commitment to pursue capital market reforms will continue.
101. While mitigation measures have been put in place for some of the key risks anticipated, the subprogram 2 did face some risks:
32
(i) Implications of global financial crisis and external vulnerabilities. The main risk from the global financial crisis has been the possibility of capital outflows that could have affected the financial sector. During 2005–2007 Indonesian macroeconomic indicators have improved significantly, which translates into better resilience to external shocks. However, Indonesian residents can switch to foreign assets easily, and there are significant foreign holdings, especially in the stock market and government bonds. Thus, Indonesia has been vulnerable to sudden shifts in investor sentiments. The Government will also have larger gross financing needs over the next 2 years, and the availability and cost of this gross financing poses risks. Stronger macroeconomic performance, a high degree of policy continuity, better fiscal performance, and improved liquidity in global financial market have mitigated these risks. (ii) Fiduciary and reputational risks. Civil society groups have also raised concerns about the proper use of development partner funds. Despite considerable improvements in the fiduciary environment in Indonesia since 2000–2001, risks had remained. Indonesia has a public sector institutional reform agenda aiming to address concerns over the quality of its public financial management procedures and processes. The World Bank’s Government Financial Management and Revenue Administration Project and other development partner programs are helping the Government to lock in and implement institutional reforms in public financial management. (iii) Sustaining reforms. The financial and operational autonomy of Bapepam-LK, which is essential for its effective supervision of the nonbank financial sector, will need an appropriate regulatory framework. Vested or competing interests might have opposed reforms being undertaken by the Government. The consolidation of reform initiatives in recent years, and the commitment by the Government to continue with reforms has ensured Indonesia is on the path to renewed rapid growth and accelerated poverty reduction. (iv) Governance and capacity constraints. Unless institutional and human capacity development had been fostered within Bapepam-LK, the implementation of reforms might have been delayed. TA will help address Bapepam-LK’s capacity weaknesses. In addition, the Government has agreed to commit, through its normal budgetary processes, expanded provisions for human development to sustain capacity building efforts over the medium and long term. ADB has provided support for anticorruption measures, including procurement reforms, during the past 7 years, and a number of ongoing activities funded by ADB have an anticorruption and capacity building focus. ADB has also supported the Partnership for Governance Reform—a cooperative relationship between the Government, civil society, the private sector, and international development partners on governance reform. (v) Enforcement constraints. Bapepam-LK continued to have difficulty implementing its compliance and enforcement mandate effectively. The CMDPC has helped to strengthen its investigation strategies and enforcement skills through clearly defined capacity building programs within Bapepam-LK.
33
VIII. ASSURANCES
102. In addition to the implementation of the actions specified in the policy matrix and to the standard assurances, the Government has given the following specific assurances, which are incorporated in the Loan Agreement.
(i) Continuity and coordination of reforms. The Government will carry out the policies and actions in accordance with the schedule of policy reforms contained in the policy matrix and ensure sustainability of the reforms beyond the subprogram 2 period. (ii) Policy dialogue. The Government will keep ADB informed of (a) the progress made in carrying out the reforms beyond the CMDPC, from time to time, and (b) the policy discussions with other multilateral and bilateral agencies that have implications for implementation of subprogram 2 or the post-program monitoring framework and will provide ADB with an opportunity to comment on any resulting policy proposals. The Government will take ADB’s views into consideration before finalizing and implementing any such proposals. (iii) Counterpart funds. The Government will use the local currency counterpart funds generated by the loan proceeds to meet program expenditures and associated costs of reform and additional budgetary allocation for the fiscal stimulus program to address the international credit crisis.
IX. RECOMMENDATION
103. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and, acting in the absence of the President, under the provisions of Article 35.1 of the Articles of Agreement of ADB, I recommend that the Board approve the loan of $300,000,000 to the Republic of Indonesia for subprogram 2 of the Capital Market Development Program Cluster from ADB’s ordinary capital resources, with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility; a term of 15 years, including a grace period of 3 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft Loan Agreement presented to the Board.
C. Lawrence Greenwood, Jr. Vice-President (Operations 2) 22 October 2009
34 Appendix 1
DESIGN AND MONITORING FRAMEWORK
Design Performance Data Sources/Reporting Assumptions Summary Targets/Indicators a Mechanisms and Risks Impact Assumptions
Greater financial sector Increase in nonbank Reports and statistics Macroeconomic stability. The resilience and financial sector’s share of published by Bank economy will be able to diversification total financial sector Indonesia, MOF, and SROs withstand the direct adverse assets from 20% to 25%– effects of the global financial 28% by 2011–2012 crisis on the level of economic activity and the distortions created in its financial markets.
Political will and commitment to pursue reforms
Risks
Implications of global financial crisis and external vulnerabilities. Risks remain, more so during a period of global financial turmoil. Outcomes Risks
Greater contribution by Increase in market Reports and statistics Fiduciary and reputational the capital market to capitalization by 20% over published by Bank risks. Indonesia has an domestic financing the medium-term–by 2012 Indonesia, MOF, and SROs enormous public sector (baseline Rp1,249.10 institutional reform agenda trillion in 2006) ADB review mission aiming to address concerns (Targets revised–market over the quality of capitalization to increase Indonesia’s public financial by 50% by 2012–as management procedures and performance exceeded processes. expectations)
A doubling of the number Lack of commitment and of individual holders of accountability. Lack of market securities, equity accountability, measurable and government bonds, outcomes, industry including through mutual commitment, and tactical funds by 2012 planning mean that the (baseline 215,025 in CMMP may run into December 2007–since implementation difficulties. increased by 58% -as of July 2009)
Outputs Assumptions
1. Enhanced Market valuation of fixed- Bapepam-LK and industry Commitment to reforms and information income instruments reports effective implementation of disclosure and achieved, leading to better TA recommendations by the improved price pricing Government discovery Improved corporate Market reports and feedback Risks governance and investor Bapepam reports protection Sustaining reforms. Vested or competing interests may oppose the reforms being
Appendix 1 35
Design Performance Data Sources/Reporting Assumptions Summary Targets/Indicators a Mechanisms and Risks undertaken by the Government. The public and Parliament will need to be persuaded of the longer-term benefits of reforms that have upfront costs.
2. Deeper and more Benchmark yield for MOF and DMO directorate Governance and capacity liquid financial government securities general data; announcement constraints. Unless markets developed through of offerings on Bank institutional and human reduction in spreads from Indonesia website capacity building takes place 20–30 basis points to within Bapepam-LK, the under 10 basis points by implementation of reforms 2010–2012 may be delayed.
Short-term yield curve Bapepam LK reports Enforcement constraints. developed leading to Government notification Bapepam-LK may have better pricing of securities difficulty implementing its compliance and enforcement Corporate bond market Bank Indonesia/Bapepam- mandate effectively. increased to 5% of GDP LK/IDX market reports by 2012
2–3 infrastructure Bapepam-LK reports financing companies established by 2010 providing longer-term financing for infrastructure development (one new company to be established in 2009 through ADB support)
Secondary market liquidity Bank enhanced through Indonesia/DGDM/IDX/KPEI adoption of master repo reports agreement by 2010
Enhanced clearing and IDX/KPEI/Bapepam-LK settlement infrastructure reports leading to increased secondary market trading volumes and reduction in trading costs by 10%– 15% by 2011–2012 (baseline 72 basis in 2005)
New products issued, IDX/Bapepam-LK reports such as sharia-based investment products, asset-backed securities, exchange traded funds, municipal bonds, and other derivative products such as stock options by 2012
Increase in number of IDX/Bapepam reports
36 Appendix 1
Design Performance Data Sources/Reporting Assumptions Summary Targets/Indicators a Mechanisms and Risks listed companies by 15 percent by 2011. (baseline 344 in 2006. Targets revised–to increase by 35% by 2011 as performance exceeded expectations )
Number of investors in IDX/Bapepam reports stock market double by 2011–2012 (baseline 215,025 in 2007. Increased by 58% since 2006)
Trading value/market IDX/Bapepam reports capitalization increased by 5%–7% every year (baseline market cap Rp1, 249.10 trillion in 2006. Increased by 50% since 2006)
Assets of private pension Bapepam-LK/Pension Biro funds increased by 5%– reports 7% every year. Private gross premium to GDP increased from 1.6% to 2% since 2003. (assets baseline Rp74, 806 billion 2006. Performance until July 2009 exceeded expectations)
Takaful insurance Bapepam-LK provided from 2009 reports/insurance industry feedback
Jakarta Stock Exchange IDX reports and Surabaya Stock Bapepam-LK reports Exchange merged in Industry feedback 2008. Broadened exchange ownership and stronger governance by 2011–2012
Increased issuance of DGTAX/Bapepam-LK sharia-based products reports though removal of tax distortions on such products in 2009; tax distortions on mutual funds removed in 2009
3. Better market Appropriate regulatory Government/MOF surveillance and structure for Indonesia's notification investor protection financial sector developed by Q1 2011, leading to
Appendix 1 37
Design Performance Data Sources/Reporting Assumptions Summary Targets/Indicators a Mechanisms and Risks enhanced system stability IDX/Bapepam reports Improved regulation and operations of the capital markets and nonbank financial sector through amendments of the three sector laws
Investors in Indonesia IDX/Bapepam reports gain access to about 120 more quality stocks through participation in the ASEAN trading board by 2011–2012
Risk-based parameters Bapepam-LK reports for insurance companies Insurance industry and pension funds association feedback strengthened
Consolidation in the Bapepam-LK reports insurance industry Insurance industry through increase in association feedback minimum capital requirements for insurance companies, leading to reduction in the number of life insurance companies by 20% and nonlife insurance companies by 25%
Enhanced investor IDX/Bapepam-LK reports protection through investor protection fund set up by 2010-2012
Anti-money-laundering PPATK reports regime strengthened in 2009
4. Stronger governance Capital Market Institute Bapepam-LK/UI/SROs and human resource established as a report and feedback capacity cooperative effort by IDX, KPEI, KSEI, UI, and Bapepam-LK in 2009, leading to enhanced quality of industry professionals
Government budgetary Bapepam-LK/MOF reports allocation of $18 million in total over 2008–2012
Database and user Bapepam-LK reports friendly website set up in 2010 to provide consolidated market information
38 Appendix 1
Design Performance Data Sources/Reporting Assumptions Summary Targets/Indicators a Mechanisms and Risks
Activities with Milestones: Inputs 1. Enhanced information disclosure and improved price discovery 1.1 Bapepam-LK monitors the progress on real-time reporting on price information ADB loan: $300 million 1.2 Bapepam-LK supports the establishment of the local bond pricing agency by 2009 1.3 Bapepam-LK develops internal process and procedures to ensure prompt Government commitment of disclosure of changes in beneficial ownership of officers, directors, and about $18 million in total over shareholders with 5% holding in public companies in line with international 2008–2012 to support practices by June 2009 Bapepam-LK's human 2. Deeper and more liquid financial markets resource development. 2.1 Presidential Decree 16/1988 amended by June 2009 to allow establishment of finance companies for infrastructure 2.2 Master repo agreement adopted by all market participants by the end of 2010 2.3 Single centralized registry for government securities established by 2010 2.4 Takaful insurance provided from 2009 2.5 Bapepam-LK considers enhancing the role of primary dealers by June 2009 2.6 Bapepam-LK issues revised rules on short selling in 2009 2.7 DGDM issues treasury bills of shorter maturity, progressively to 1 month, between October 2007 and June 2010 2.8 DGDM directorate general monitors market making obligations of primary dealers in coordination with Bapepam-LK and Bank Indonesia 2.9 Bapepam-LK introduces straight through processing by June 2010 2.10 Continuous net settlement introduced by June 2010 2.11 Government issues sukuk bonds from 2008 2.12 Rules for issuing and trading stock options and index-based options drafted for approval by Bapepam-LK by June 2009 2.13 Legal basis for sharia-based operations submitted to Parliament by June 2009 3. Better market surveillance and investor protection 3.1 Task force set up in August 2009 to examine alternative regulatory structures 3.2 Task force completes study on regulatory structures by end 2009 3.3 Bapepam-LK decides on regulatory structure to enhance its independence and powers by early 2010 3.4 Draft amendments of the three sector laws—capital markets, pension and insurance—submitted to President office in April 2010 3.5 The three sector laws submitted for parliamentary consideration in 2010 3.6 IDX enters into bilateral MOUs with five other participating ASEAN exchanges to set up ASEAN trading board in 2009 3.7 Bapepam-LK monitors implementation of the merger of Jakarta stock exchange and the Surabaya Stock exchange 2008–2009 3.8 PT Lembaga Penilaian Harga Efek Indonesia (established on 28 December 2007) application for operating as a bond pricing agency considered by Bapepam by June 2009 3.9 DGDM establishes a scheme of securities lending facility by June 2009 3.10 Sovereign sharia securities, on approval of the Parliament, become a legal basis for Government to issue sukuk 3.11 Bapepam-LK develops a new tool for its pension funds’ risk-based supervision 3.12 Risk-based parameters for insurance companies and pension funds strengthened. Minimum capital requirements for insurance companies increased progressively from 2010 to 2014 3.13 Investor protection fund set up by 2010-2012 3.14 Fund managers to utilize Independent valuation provided by bond pricing agency 4. Stronger governance and human resource capacity 4.1 Comprehensive FSAP +++ assessment undertaken in 2009 and 2010, and resolution of findings 4.2 Anti-money-laundering regime strengthened in 2009 4.3 Capital Market Institute established as a cooperative effort by IDX, KPEI, KSEI, UI, and Bapepam-LK in 2009
Appendix 1 39
Design Performance Data Sources/Reporting Assumptions Summary Targets/Indicators a Mechanisms and Risks Activities with Milestones: 4.4 Government budgetary allocation of $18 million in total over 2008–2012 4.5 Database and user-friendly website set up in 2010 to provide consolidated market information 4.6 Capital market master plan developed in 2009 for 2010–2014 a Some of the targets have been revised as performance exceeded expectations (para. 68 for accomplishments). DGDM = Directorate General Debt Management; DGTAX = Directorate General Tax; IDX = Indonesia Stock Exchange; KPEI = Indonesian Clearing and Guarantee Corporation; KSEI = Indonesian Central Securities Depository; MOF = Ministry of Finance; SRO = self-regulatory organization; UI = University of Indonesia Source: Asian Development Bank.
40 Appendix 2
SECTOR STUDY
A. Regional Comparison of Indonesia's Financial System
1. In terms of composition and growth, Indonesia’s financial system has not progressed much since 2005 compared with those of its neighbors. Although the Indonesian capital market had been the best performing in the region, its breadth and depth and enforcement of regulation and supervision still need to be addressed. The long-term debt market had been constrained by delays in pension and insurance sector reforms. Much liquidity was locked up in government bonds. In 2008, with total banking assets as a percentage of gross domestic product (GDP) of 43.8%, Indonesia had the smallest market in this region. With equity market capitalization as a percentage of GDP of 21.8% in 2008—it dipped because of the global crisis but has since improved—Indonesia had the smallest market, with Hong Kong, China ahead of the pack, followed by Singapore, Republic of Korea, Malaysia, People's Republic of China, the Philippines, and Thailand. Indonesia also had the smallest debt market of the countries in Table 2 of the main text with the percentage of bonds outstanding to GDP of 13.6%.
B. Banking Institutions in Indonesia
2. Bank Indonesia announced plans in January 2005 to strengthen the banking sector by encouraging consolidation and improving prudential banking and supervision. Bank Indonesia hopes to encourage small banks with less than Rp100 billion in capital to either raise more capital or merge with healthier "anchor banks" before the end of 2010. It also announced the criteria for anchor banks in July 2005. Bank Indonesia plans to improve operations of its credit bureau to centralize data on borrowers. Another important banking sector reform was the decision to eliminate the blanket guarantee on bank third-party liabilities.
3. Loan quality and risk management in the banking industry. Since the nonperforming loans (NPL) ratio of banks peaked at 48% in 1998, the asset quality of commercial banks in Indonesia has recovered. The NPL ratio of commercial banks fell to 4.07% in 2007 and 3.8% by the end of 2008, and was 4.2% as of April 2009—an improvement over 2005, but still higher than in Malaysia (2.2%). Stronger corporate balance sheets, including less reliance on external financing, have also reduced risks. The average capital adequacy ratio in Q1 2009 is about 17.82% is well above the prescribed prudential norm of 12%, and higher than the average in Malaysia (12.10%) and Thailand (14.16%).
Table A2.1: Health of the Indonesian Banking Sector (%)
Item 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Q1 2009
NPL 7.2 48.6 32.9 18.8 12.1 7.4 6.8 6.2 7.6 7.0 4.07 3.8 4.2
Rate of 1.4 (18.8) (6.1) 1.6 1.5 2.0 2.63 3.46 2.55 2.64 2.78 2.33 2.76 return on assets Capital 9.1 (15.7) (8.1) 2.1 18.9 22.4 19.4 19.4 19.3 21.2 19.3 16.7 18.0 adequacy ratio NPL = nonperforming loan. Source: Bank Indonesia; CEIC Data Company.
Appendix 2 41
C. Nonbank Financial Sector
4. Underdeveloped. The nonbank financial sector accounts for about one-fifth of total financial assets. The sector includes securities brokers and dealers, derivative market, mutual funds (also known as investment companies), insurance companies, pension funds, pawnshops, rural institutions, and venture capital companies. In line with Indonesia’s long-term development agenda and development priorities, the Government considers development of the nonbank financial sector urgent and imperative. Indonesian institutional investors are small and have not been a source of long-term capital. Pension funds and insurance companies invest a significant portion of their resources in short-term bank deposits.
5. Shallow equities market. The market capitalization of Asian equities has tripled since 1997. Capitalization as a percentage of GDP in Southeast Asian economies such as Hong Kong, China; Malaysia; and Singapore compares favorably with that of Germany, the United Kingdom, and the United States. Indonesia’s equities market remains one of the smallest in Asia and the Pacific. The number of listed companies increased from 336 in 2005 to 401 as of July 2009 with total market capitalization of Rp1,719 trillion.
6. Small bond market. Compared to other economies in Asia, the bond market in Indonesia is still small. The bond market dropped to 13.6% of GDP in 2008 from 22.2% in 2007.
7. Government bond market. At 12.3% of GDP, the government bond market in Indonesia is among the smallest in Asia. Only Hong Kong, China at 9.1% of GDP is smaller, but it has a sizeable corporate bond market at 30.4% of GDP. Although the capital market remains small and illiquid, Indonesia has been issuing significant volumes of government bonds. Liquidity in the domestic market began to ease in January 2009.
Table A2.2: Size and Composition of Local Currency Bond Market
Amount (billion) Growth Rate (%)
Item Sep 2008 Oct 2008 Nov 2008 Dec 2008 Sep 2008 Oct Nov Dec 2008 2008 2008 IDR $ IDR $ IDR $ IDR $ y-o-y q-o-q m-o-m m-o-m y-o-y q-o-q m-o-m
Total 736,560 77 752,939 69 775,667 65 (9.7) (3.9) 22 3.0 Government 658,669 69 679,274 63 702,232 58 (10.3) (3.7) 3.1 3.4 Central 541,700 56 541,700 50 534,455 44 525,695 46 15.7 4.4 0.0 (1.3) 11.0 (3.0) (1.6) Government bonds
Central bank 116,969 12 137,574 13 167,777 14 (56.1) (29.2) 17.6 22.0 bonds
Corporate 77,890 8 73,665 7 73,435 6 73,010 6 (9.7) (5.6) (5.4) (0.3) (7.7) (7.7) (0.6) ( ) = negative, IDR = Sources: Bank Indonesia, Indonesia Stock Exchange, and Bloomberg LP/ http://asianbondsonline.adb.org/indonesia/writeup/writeup_2008_q1_id.pdf.
8. Credit default swap. In line with global conditions, credit defaults swaps have spiked, as indicated in Table A2.3. They increased steadily from 2007 to their peak in September 2008 before falling from December 2008 to a significantly lower level in June 2009.
42 Appendix 2
Table A2.3: Credit Default Swaps
Sovereign CDS Level 5 Year Economy Dec 2007 Mar Mar Jun Sep Dec Jun Ratings 2007 2008 2008 2008 2008 2009 People's Republic 11 13 20 29 81 75 90 188 156 82/92 A/A1 of China Indonesia 119 110 142 154 245 286 357 638 575 315/125 BB/Ba3
Malaysia 16 16 25 44 99 116 171 225 238 115/125 A–/A3 Philippines 120 111 145 153 243 266 284 384 360 215/235 BB–/B1 Thailand 42 39 43 55 111 135 172 256 233 120/130 BBB/Baa1 Hong Kong, 5 5 9 18 58 42 62 104 145 China Republic of Korea 17 17 24 47 97 107 82 319 328 161/169 A/A2 CDS = credit default swap Source: Asian Development Bank.
9. Corporate bond market. The corporate bond market was only 1.3% of GDP in 2008, compared with the government bond market at about 12.3% of GDP. The size of the market has shrunk from 2.0% in 2007. This percentage is low compared to many of Indonesia's neighboring countries—Republic of Korea (47.0%); Malaysia (34.6%); Hong Kong, China (30.4%); Singapore (29.0%); Thailand (10.4%); and the Philippines (3.3%). However, the potential for the development of corporate bond market in Indonesia is vast given the significant number of infrastructure development projects in the pipeline. However, this will require a more comprehensive policy and serious efforts on the part of Government and private sector. Greater transparency is expected in the future with the establishment of the Bond Pricing Agency, but much more needs to be done. This also relates to the low level of market capitalization of listed companies on the Indonesia Stock Exchange (IDX) and small number of listed companies.
Table A2. 4: Local Currency Corporate Bond Market (% of GDP)
Economy 2007 2008 Country 2007 2008 People's Republic 4.4 6.1 Philippines 2.6 3.3 of China
Hong Kong, China 38.8 30.4 Singapore 31.7 29.0
India 3.6 4.5 Thailand 11.0 10.4 Indonesia 2.1 1.4 Viet Nam0.5 0.6 Malaysia 35.8 34.6 Emerging East Asia 13.6 12.5 Total corporate
Republic of Korea 54.9 47.0 Japan 16.8 19.8
Note: 2008 GDP from the Economic Outlook Database, October 2008, IMF. Other GDP data from CEIC. Sources: People's Republic of China (ChinaBond); Hong Kong China (HK Monetary Authority); India; Indonesia.
10. Collective investment scheme. A similar trend in the erosion of value was observed for collective investment schemes, where total net asset value fell from Rp92.19 trillion in 2007 to Rp74.06 trillion in 2008, However, this decline did not affect the growth of units, which increased by 13.8% to 61.51 billion units in 2008. A total of 602 funds were offered in 2008, compared to 473 at the end of 2007.
Appendix 2 43
11. Sharia-based capital market products. Islamic finance in Indonesia is newer than conventional finance, but has grown rapidly. Bank of Indonesia has developed a blueprint for sharia banking based on Islamic principles. Sharia-based capital market products were introduced in Indonesia by a sharia investment fund in mid-1997. The Government is working on a comprehensive framework on Islamic finance covering legal, rules, accounting, and tax structure to support its growth. Parliament approved a law on sovereign sharia securities on 7 May 2008; it forms a legal basis for the Government to issue and utilize sovereign sharia securities to mobilize funds and finance national development. The law covers sovereign sharia securities in domestic and foreign currencies. In addition, Bapepam-LK issued its Rules on the Issuance of Shariah Securities and Criteria and Issuance of Shariah Securities List (Revised) in June 2009. Market participants have adopted 70% of the guidelines on the presentation of financial statements for selected instruments; full adoption is expected by 2012. Bapepam-LK has been involved in discussions with the Indonesian Accounting Association to formulate accounting standards for the issuance of sharia securities. In regard to the development of Islamic insurance, takaful, the Ministry of Finance will be submitting a bill to Parliament to strengthen the legal basis for takaful operations.
12. To address the tax disincentives for sharia-based products, Parliament approved the new Income Tax Law (36/2008; article 31d), which allows the Government to regulate sharia- based instruments. Another government regulation (25/2009) approved in March 2009 provides for similar tax treatment as applied to conventional bonds to eliminate any disparity. In July 2008, Parliament approved the issuance of government sukuk worth $2 billion. With credit markets tight, the Republic of Indonesia sold $650 million 5-year global sukuk, closing on 16 April 2009. Many see this development as a strong indication of the administration’s increased attention to developing sharia finance. It was the first dollar-denominated Islamic bond in the world in 2009 and is expected to spark demand for more.
13. Newly introduced financial products and services. These include (i) exchange traded funds, (ii) asset-backed securities (although no company has issued such securities since the regulations were introduced), (iii) single-stock futures, and (iv) stock lending and borrowing. A Presidential decree on secondary mortgage financing was issued in February 2005 establishing the Secondary Mortgage Corporation (PT Sarana Multigriya Finansial). Its function is to purchase qualified mortgages from financial institutions and issue bonds backed by these assets. The target market for these mortgage-backed securities will be long-term investors, such as insurance companies and pension funds. During the Secondary Mortgage Corporation's first 3 years of operations, it is expected to lend to financial institutions, which will onlend for qualifying mortgages, to build up the critical mass of primary mortgage receivables. The loans will help build qualified mortgage portfolios for purchase by Secondary Mortgage, as well as a track record in the lower- and middle-income echelons of society.
D. Market Infrastructure
14. Indonesia Stock Exchange. Based in Jakarta, IDX was previously known as the Jakarta Stock Exchange (JSX) before its name was changed in 2007 after merging with Surabaya Stock Exchange (SSX). The merger included in the Capital Market Master Plan (2005-2009) and the 2006 Financial Sector Policy Package has been completed and IDX has started operations. However, Indonesia still maintains two systems for clearing, settlement, and deposits: the Indonesian Central Securities Depository (KSEI) and the Indonesian Clearing and Guarantee Corporation (KPEI). IDX, KSEI, and KPEI are self-regulating organizations with the authority to set rules and oversee the activities of brokers, dealers, and custodian banks dealing in securities and bond trading. Indonesia has 158 securities brokerages end 2008. Established
44 Appendix 2 in 1994, Pefindo is Indonesia’s largest rating agency. It is an affiliate of Standard and Poor’s and has adapted its rating methodology. The only other rating agency is PT Fitch Rating Indonesia, incorporated in 2006. It focuses on asset-backed securities, including plans for securitized mortgages, which have not developed yet in Indonesia as the first securitized mortgage was only issued in 2009. Development of the financial sector and the capital market in particular is hampered by an inability to obtain and/or enforce timely commercial judgments. Other agencies have provided support to the judiciary to enhance its capacity, but more assistance is required.
15. High trading cost. Table A2.5 provides total trading cost, which includes commissions and fees charged for trading in 13 countries, including Indonesia. Overall, the average total trading cost fell from 46.80 basis points in 2005 to 39.83 basis in 2008 with most jurisdictions showing declines. Based on total trading cost of 72.00 basis points in 2005 and 52.98 basis points in 2008, Indonesia is the least cost-effective market after the Philippines. Most countries in this region had cost-efficient trading in 2008—Malaysia (41.10 basis points); Thailand (42.73); Singapore (35.50); and Hong Kong, China (41.42).
Table A2.5: Trading Costs
Total Trading Costa Commission and Fees Market Impactb Economy 2005 2008 2005 2008 2005 2008 Philippines 99.00 80.47 75.00 69.33 24.00 11.14 Indonesia 72.00 52.98 56.00 42.61 16.00 10.37 Thailand 66.00 42.73 43.00 30.11 23.00 12.62 Malaysia 60.00 41.11 39.00 30.32 21.00 10.79 Singapore 40.00 35.5 28.00 24.21 12.00 11.29 Republic of Korea 58.00 50.3 42.00 39.38 16.00 10.92 Taipei,China 54.00 49.42 38.00 39.00 16.00 10.42 Hong Kong, China 41.00 41.42 32.00 28.83 9.00 12.59 Japan 20.00 21.5 14.00 15.92 6.00 5.58 UK 29.00 47.45 16.00 40.24 13.00 7.21 NASDAQ 30.00 17.51 17.00 12.07 14.00 5.44 NYSE 17.51 13.89 15.00 9.77 8.00 4.12 Germany 22.00 23.56 18.00 16.11 5.00 7.45 NASDAQ = National Association of Securities Dealers Automated Quotation; NYSE = New York Stock Exchange; UK = United Kingdom a Total fees charged for trade execution, clearing, and settlement. b Market Impact: Adverse price movement as a result of the trade—defined as the gap between executed price and last bid/offer. Source: Elkins McSherry Survey.
16. Small insurance sector. The insurance industry is still small in terms of the ratio of premiums to GDP, although it grew from 1.57% in 2006 to 1.88% in 2007. The gross premiums collected by the insurance industry in 2007 reached Rp74.51 trillion, 42% higher than the Rp52.42 trillion collected in 2006. Since 2003, the annual growth of gross premiums has averaged about 20%. Insurance companies invest about 25% of their assets in short-term deposits. Based on an unaudited insurance report, the assets of the 142 insurance companies totaled Rp201.99 trillion, or 4.1% of GDP, as of December 2008.
17. Unlike in banking, large-scale corporate failures have not been seen among insurers, mainly because regulations required insurers to hold a high proportion of their funds in bank
Appendix 2 45 deposits. Indonesia has 51 life insurance companies, 97 general insurance companies, and 4 reinsurance companies. The industry is heavily concentrated, with the top five general insurance companies accounting for 51% of general insurance assets and the top five life insurance companies accounting for 55% of life insurance assets. The licenses of eight companies—five life insurance and three general insurance—were withdrawn in 2006. The Government still needs to address the remaining one state life and two insolvent general insurance companies. The market is open to new entrants, and some of the major multinational firms are represented in both sectors. A draft insurance law (including provisions on takaful) is expected to be submitted to Parliament for approval by the end of 2009.
18. In terms of insurance penetration, based on premiums in percentage of GDP in 2007, Indonesia ranked 60 in the world, far below the Republic of Korea (5); Hong Kong, China (6); Singapore (18); Malaysia (32); and Thailand (41).
Table A2.6: Insurance Penetration: Premiums in % of GDP in 2007
World Enomomy Total Business Life Non-life Business Ranking Business 5 Republic of Korea 11.8 8.2 3.6 6 Hong Kong, China 11.8 10.6 1.2 10 Japan 9.6 7.5 2.1 18 Singapore 7.6 6.2 1.5 32 Malaysia 4.6 3.1 1.5 41 Thailand 3.4 1.8 1.5 48 People's Republic China 2.9 1.8 1.1 69 Indonesia 1.6 1.1 0.5 73 Philippines 1.5 0.9 0.5 74 Viet Nam 1.5 0.8 0.7 Source: Swiss Re Economic Research & Consulting.
19. Small pension sector. In Indonesia, the pension sector is small, accounting for less than 4.7% of GDP in assets, compared with Thailand (8.4%), Malaysia (57%), and Australia (75%). Indonesia had 288 private pension funds with net assets of Rp69.17 trillion as of June 2008, covering privately managed employer pension funds and financial institution pension funds. Only 12% of the workforce is covered by the public pension and old-age savings programs, provided by PT Jamsostek for private sector workers, by PT Taspen for civil servants, and by PT Asabri for the military. Less than 2% of the workforce is covered by voluntary private pensions. The Private Pensions Law (11/1992) will be reviewed and amendments will be submitted together with the amendments proposed to the Capital Market Law and the Insurance Law. The main impediments are (i) private pensions have to compete with other financial products, such as mutual funds and insurance, which are more flexible (allowing for early withdrawals) and have better tax benefits; (ii) private pension savings have to be converted into annuities at unattractive rates at retirement age; and (iii) although taxation of private pensions is theoretically an exempt-exempt-taxable regime, in practice this is not the case.
20. Bapepam-LK oversees the voluntary pension schemes. Overall, the pension sector is characterized by low coverage and limited capitalization. About half of the assets are in public programs, and half in private programs. To enhance the performance of the pension fund industry, the Ministerial Decree on Pension (Decree 199/PMK-010) was issued in December 2008 to allow for investment in a wider range of domestic instruments. There is no unified program providing pensions for Indonesians, although several schemes promising lump sum benefits or pensions for various segments of workers exist. Civil servants receive lump sum
46 Appendix 2 benefits and monthly pensions after retirement. The same benefits are also granted to members of the armed forces. A provident fund is established for private workers providing lump sum benefits upon reaching the age of 55. Monthly pensions are still luxury for most private workers as only few employers adopt and implement pension programs voluntarily. No formal program has ever been established for informal workers to make income available in old age. However, since the enactment of the Pension Funds Law (No. 11/ 1992), the private pension sector has grown steadily. Total assets of all private pension funds (employer pension funds and financial institution pension funds) at the end of 2007 were Rp90 trillion. More than 4,400 employers and about 2.5 million active participants and beneficiaries participate in various pension programs.
E. Impressive Improvement in Indonesia's Competitiveness1
21. The institutional reforms pursued by Indonesia in recent years have begun to bear fruit. The IMD Competitive Center—a leading world think tank and educational institution based in Lausanne, Switzerland—reported a major improvement in Indonesia's global competitiveness. Indonesia moving up from 51st to 42nd among the 57 major nations surveyed worldwide. These results are published in the IMD World Competitiveness Yearbook 2009. Indonesia now stands in the same group as other emerging markets such as Brazil and ahead of the Philippines, Mexico, South Africa and the Russia Federation. Despite this, Indonesia’s competitiveness remains below that of India, Thailand, the People's Republic of China, and Malaysia.
22. In ranking these nations, the IMD applied 329 criteria. Two-thirds of the criteria are objective indicators in the form of statistics and other quantitative data, while the remainder are perception indicators obtained through interviews. The rankings for 2009 are based on results and data from 2008. For Indonesia, the improvement in 2009 was achieved through significant gains in economic performance, which climbed from 52nd place in 2009 to 41st in 2009, followed by government efficiency (up from number 38 in 2008 to 31 in 2009) and business efficiency (from 44 to 38). Indonesia still needs to improve infrastructure, an area in which its ranking slipped from 51st in 2008 to 53rd in 2009. The IMD also performed stress testing to assess country resilience to economic crisis. The stress test results show that Indonesia ranks 33rd in resilience to the global crisis. Of the four factors assessed in the stress test, Indonesia’s resilience for the government factor rank best at 26th. For the other three factors, Indonesia ranked 33rd in economic forecasts, 36th in business, and 33rd in society.
1 IMD. 2009. World Competitiveness Yearbook 2009. The Coordinating Ministry For Economic Affairs of The Republic of Indonesia.
47 Appendix 3
DEVELOPMENT COORDINATION MATRIX
Banking and Formal Credit Capital Markets, Corporate Rural and Microfinance (including SMEs and trade Governance, and Nonbank finance) Financial Institutions ADB (i) Financial Sector and Social Security Reform Program (a) Time frame: 2002–2004 (b) Budget: $250 million (policy-based) loan (ii) Support for establishment of Indonesia Infrastructure Facility (together with World Bank, AusAID, and DEG). ADB's approved equity investment of up to $40 million and loan funding of up to $100 million (iii) Establishment of a financial services authority (a) Time frame: 2002–2007 (b) Budget: $1,500,000 TA grant Technical and capacity building support to Bapepam-LK. (iv) Development of an AML Regime (Phase II) (a) Time frame: 2004–2006 (b) Budget: $500,000 TA grant (v) SME Export Development Project (a) Time frame: 2002–2007 (b) Budget $85 million loan (credit line) Australia AusAID (i) Technical Assistance Management Facility (TAMF) III (a) Time frame: 2004–2009 (b) Budget: A$26 million The main focus is on supporting restructuring of Bapepam-LK and strengthening the AML regime. Other areas include support for debt management, fiscal policy, SOE divestment, Financial Stability Forum, bank oversight, and development of the Financial Sector Policy Package. (ii) Insurance: undertake review and research on the feasibility of compulsory motor vehicle insurance expected to be completed between September and December 2009 (iii)Pension: feasibility study for the introduction of mandatory private sector pensions, scheduled for completion by October 2009. (iv) Support for KSSK (Stability Forum): includes support for simulation exercises, policy making capacity building, assistance with FSAP, and financial sector architecture development. (v) Support for Tax Office, DG Debt, Bappenas, Ministry of Trade, as well as component on audit oversight. (vi)Support for establishment of indonesia infrastructure facility (with ADB, World Bank, and DEG) (vii) Government Partnership Fund (a) Time frame: 2005–2010 (b) Budget: up to A$50 million total. Provides TA and training support including support for secondments of Australian staff to Indonesian counterpart organizations and vice versa. Germany KfW DEG GTZ Proposed credit line for small and Support for establishment of Promotion of small financial medium-sized industries Indonesia infrastructure facility (with institutions. MFI-related TA Budget: €27 million loan; ADB, World Bank, and AusAID. support to Bank Indonesia. €1.5 million grant; €3 million
48 Appendix 3
Banking and Formal Credit Capital Markets, Corporate Rural and Microfinance (including SMEs and trade Governance, and Nonbank finance) Financial Institutions TA grant Japan JICA Support for capital market development United States USAID Support to the Deposit Insurance (i) Capacity building support for the Guarantee facility to Bank Agency (LPS) insurance industry through support Danamon for micro and (a) Time frame: 30 months for establishment of Institute of Risk small enterprise loans in (b) Budget: $3.6 million Management tsunami-affected areas. TA and training support along (ii) Support package for Bapepam-LK with provision of IT equipment for (being finalized) focused on municipal establishment and bond market development, operationalization of LPS securitization, and risk-based (completed). surveillance (time frame is 4 years and budget is $15 million).
AML- and CFT-related TA support World Bank (i) Conduct of Financial Sector (i) TA support to Bapepam-LK to Survey of 3,000 rural Assessment Program. review business sustainability of households regarding (ii) Study on role of institutions employer pension funds (DPPK). access to financial services involved in trade financing in Also support for study on (study is being finalized and Indonesia. development of options for policy is targeted for publication in holder protection scheme. late 2009). (ii) Support for establishment of Indonesia infrastructure facility (with Study on access to finance ADB, AusAID, and DEG). World for migrant workers including Bank's contribution includes equity assessment of options for investment of up to $40 million and insurance. loan funding of up to $100 million. (iii) Conduct of Financial Sector Assessment Program.
ADB = Asian Development Bank, AML = anti–money-laundering, APRA = Australian Prudential Regulatory Authority, ASIC = Australian Securities and Investments Commission, AusAID = Australian Agency for International Development, CFT = Credit Fund Transfer, DEG = Deutsche Investitions and Entwicklungsgesellschaft, DPPK = Deutsche Arbeitsgruppe zur Psychologie der Persönlichen Konstrukte, EU = European Union, IMF = International Monetary Fund, SME = small and medium-sized enterprise, TA = technical assistance, TAMF = technical assistance management facility, UNODC = United Nations Office on Drugs and Crime, USAID = United States Agency for International Development. Source: Asian Development Bank and development partners.
POLICY MATRIX AND DEVELOPMENT POLICY LETTER
Indonesia Capital Market Development Program Cluster (Subprogram 2) Policy Matrix October 2007 – August 2009
No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011 (1) Enhancing information disclosure and improving price discovery 1.1. Strengthen Bapepam-LK to progress towards (i) Progress towards real time price information (i) Bapepam-LK to further progress towards price real time price information. real-time price information by reducing information (ii)Support the establishment and reporting time for off-exchange trades disclosure and operationalization of a bond pricing agency (BPA) (ii) Bapepam-LK to encourage BPA to enhance market by the private sector. diversify shareholding. valuation of Agency: (Bapepam-LK) (iii) BPA to have in place an effective system fixed income Status: Accomplished. that allows for credible pricing of bonds and instruments timely dissemination of information to subscribers 1.2. Improve market Bapepam-LK to develop internal Bapepam-LK to issue rule requiring the Depository Bapepam-LK to monitor ongoing compliance transparency processes, procedures, and KSEI to report to Bapepam-LK within T+4 days systems to enable prompt public (with information to IDX) any change in beneficial disclosure of changes in ownership of 5% or more that each director, beneficial ownership of officers, commissioner and shareholder have in the paid in directors and significant capital of an Issuer or Public Company and IDX to shareholders with 5% holding of make such information public within T+5 days i.e. public companies in line with within a period of no later than 5 (five) work days international good practice. after the transaction date. Agencies: Bapepam-LK; IDX Status: Accomplished.
A Bapepam-LK to issue rules to provide for greater 4 ppendix transparency and accountability of credit rating agencies. 49
1 Policy measures highlighted in bold are to be considered as triggers for the follow-up program proposed in 2011–2012
50
Appendix 4 Appendix No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011
Agency: Bapepam-LK Status: Accomplished.
(2) Promoting deeper and more liquid capital markets 2.1 Bapepam-LK in coordination with BI in coordination with Bapepam-LK, DG DM, DG BI in coordination with Bapepam-LK, DG BI to address issues constraining Tax, and market players to undertake a DM, DG Tax, and market players will wider adoption of the master comprehensive review of the legal and business formulate and finalize a comprehensive agreement for repurchase requirements for adoption of the General Master repurchase agreement addressing: agreements. Repurchase Agreement (GMRA). (a) taxation, risk exposure, dispute Agency: BI to work in coordination with Bapepam- minimizing, etc; LK (b) compatibility issues of the current Status: Accomplished. MRA to GMRA utilizing international best practices, as appropriate, the Indonesian annexes. The review will lead to a finalized repurchase agreement for all transactions involving market participants. BI will: (a) advocate the adoption of the finalized repurchase agreement by banks for all repurchase agreement related transactions; and (b) consider the finalized repurchase agreement for its repurchase agreement related transactions. 2.2 Bapepam-LK to consider Complete drafting and consultation process by 30 Bapepam-LK to prepare a comprehensive enhancement of role of June 2009 in preparation for issuance of rules by secondary market regulation to cover Himdasun (primary dealers 30 September 2009 that will place it in a more individual registered persons (bond dealers), association) in bond market to direct supervisory role with respect to government code of conduct for market intermediaries support regulatory surveillance bond dealers to enable enhanced bond market with regard to trading practices, operation surveillance. risk standards, and minimum transactional Agency:, Bapepam-LK contract standards and initiate introduction of
No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011 Status: Accomplished. GMRA. 2.3 Bapepam-LK to revise Revise regulations on short selling/margin trading Monitor short selling and applicable rules to regulations on short in securities to incorporate international best ensure continuing support for market selling/margin trading in practices. development. securities to incorporate Agency:, Bapepam-LK international best practices. Status: Accomplished.
2.4 BI to develop a centralized Incorporate the business requirement for a BI to finalize formulation of request for securities borrowing and lending centralized securities lending and borrowing proposal for BI-S4 along with functional program for government bonds. program into its future development of BI-S4 (new specifications for BI-S4. generation system). Agency: Bank Indonesia Status Accomplished. 2.5 DG DM to provide regular (i) Provide regular updates to annual auction DG DM to update the quarterly calendar on updates to annual auction calendar, on a quarterly basis to market a more frequent basis as appropriate. calendar, on a quarterly basis to participants to provide clarity on issuance market participants to provide expectations. clarity on issuance expectations. Agency: DG DM, MOF
Status: Accomplished. DG DM to progress issuance of (ii) Increase range of T-bill maturities on offer to DG DM in coordination with BI, short-term T-bills down to 1 develop a short term yield curve. appropriately replace SBIs with T-bills month maturity Agency: DG DM, MOF (with increased range of maturities) to Status: Accomplished. promote liquid short-term Government securities market 2.6 Bapepam-LK in consultation with (i) Bapepam-LK in coordination with BI and DG DM BI and Bapepam-LK in coordination with DG BI to undertake a study on the to arrive at a framework for depository DM to support a single, centralized registry feasibility of a single centralized consolidation of Government bonds under each to achieve efficiency for trading of custody/registry to consolidate all entity (S4 and KSEI) Government securities. A
capital market depository activity Agencies: BI; DG DM, MOF 4 ppendix under one entity. Status: Accomplished. Implement single, centralized registry for Government securities.
DG DM in association with (ii) Review suitability of non-bank primary dealers BI and Bapepam-LK to plan an appropriate 51 Bapepam-LK to request BI to
52
Appendix 4 Appendix No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011
allow nonbank primary dealer to as open market operations participant. platform to allow NBFIs direct access to the participate in BI repurchase Agency: BI BI repurchase agreement window, in agreement window. Status: Accomplished. particular, during a crisis, through revision of its Act and regulations, providing these NBFIs meet BI prudential standards 2.7 New market Bapepam-LK to require (i) Launch ETF. IDX to expand offerings of ETFs in line with products to be Exchange to issue listing rules for Agency: IDX market demand. developed ETFs. Status: Accomplished. including: Bapepam-LK to issue rules to (ii) Issue rules to enable the establishment of real MOF to address tax issues affecting REITs enable the establishment of real estate investment trusts. by supporting Parliamentary discussion and estate investment trusts Agency:, Bapepam-LK resolution of these issues through regulatory reforms. Status: Accomplished.
Sukuk to be issued by the Government to continue to support (iii) Government to establish legal and regulatory Government. development of Sukuk market. framework for Sukuk issuance.
Agency: DG DM, MOF
Status: Accomplished. MOF to commence regular issuances of (iv) Government to issue Sukuk. local currency Sukuk by auction. Agency: DG DM, MOF
Status: Accomplished.
(iv) Government to issue retail Sukuk. MOF to publish calendar of local currency Agency: DG DM, MOF Sukuk issuances. Status: Accomplished.
(v) Rule IX.A.13 on Issuance of Sharia Securities Bapepam-LK to support the Government to continue support (revised), to enhance the development of Shariah development of Shariah compliant products. issuance of new Shariah- Capital Market through (a) added clarity on compliant products. definitions, (b) additional requirement on disclosure for issuance of Shariah mutual funds, (c) expanded types of Shariah complaint securities for portfolio of Shariah mutual funds, and (d) extension of the period for disposal of non-compliant products. Rule II.K.1 on Criteria for Issuance of Shariah Securities List (revised) to enhance the
No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011 development of Shariah Capital Market through (a) expanded list of Shariah compliant securities, and (b) additional requirements for parties eligible to develop Shariah compliant securities list. Agency: Bapepam-LK Status: Accomplished. 2.8 Bapepam-LK to facilitate (i) Facilitate development of asset backed development of asset backed securities market. securities market. Agency:, Bapepam-LK Status: Accomplished. (ii) Facilitate issuance of asset backed securities. Agency: PT SMF Status: Accomplished. (iii) Amend Presidential decree to enhance the PT SMF in cooperation with Bapepam-LK to mortgage-backed securities market, by enabling develop the mortgage credit insurance (a) PT SMF to refinance for long-term tenors (up to based on relevant studies. 15 years) and (b) standardized mortgage documents to be introduced. Agency:, Bapepam-LK Status: Accomplished. 2.9 New Action. Amend Presidential decree 61/1998 to enable Develop competing Infrastructure financing establishment of infrastructure financing companies to facilitate development of companies. infrastructure. Agency: Bapepam-LK Status: Accomplished. 2.10 Bapepam-LK to require the IDX Exchange to prepare and submit for approval Bapepam-LK to approve revised rules to (Exchange) to prepare and updated rules and regulation for issuance and allow trading of stock options and index- submit for approval rules and trading of stock options and index-based futures. based futures. A regulation for issuance and 4 ppendix Agency: Bapepam-LK and IDX trading of stock options and Status: Accomplished. index-based futures.
DG DM to coordinate with the Exchange to develop DG DM to coordinate with the bond index futures contracts. 53
54
Appendix 4 Appendix No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011
Exchange to develop bond index Agency: DG DM, MOF futures contracts. Status: Accomplished.
2.11 Bapepam-LK to provide technical Bapepam-LK to work with IAA to facilitate issuance IAA in consultation with Bapepam-LK to support to Indonesian Accounting of exposure draft of Shariah accounting standards finalize and adopt Shariah accounting Association for the application of for selected instruments. standards for selected instruments. Shariah principles in Shariah- Agency: Bapepam-LK based capital market. Status: Accomplished.
Bapepam-LK to support the issuance of Shariah- compliant products by developing draft guidelines on presentation of financial statement for selected instruments. Agency: Bapepam-LK Status: Accomplished. 2.12 New Action. Progressively adopt International Financial Bapepam-LK in coordination with IAA to Reporting Standards (IFRS). progress towards full compliance with Agency: Bapepam-LK International Financial Reporting Standards Status: Accomplished. (IFRS). 2.13 Enhance the (i) Issue Ministerial decree on Pensions to allow for Bapepam-LK to develop Ministerial Decree performance of investment in wider range of domestic instruments establishing fit and proper test for pension the contractual Agency: Bapepam-LK fund administrators. savings industry Status: Accomplished (ii) Bapepam-LK to include provisions in draft pension law to allow for, among other things, (a) entry into pension fund administration by a wider range of appropriately qualified entities [e.g. investment managers], (b) greater independence of
fund management from interference by founder, and (c) appointment of statutory manager in crisis situations. Agency:, Bapepam-LK Status: Accomplished.
No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011 (iii) Bapepam-LK to complete first round consultations with industry on the draft insurance Socialization of draft insurance law law (including takaful) and initiate the finalization of completed and draft finalized with the draft insurance law. submission to the President by April 2010 Agency:, Bapepam-LK with submission to Parliament later in Status: Accomplished. 2010. (iv) MOF (with ADB support) to prepare draft white paper on pension, old age savings and death benefit schemes under the new social security White paper finalized and submitted to system (SJSN) for submission to the National National Social Security Council. Social Security Council. Agency: MOF, Bapepam-LK Status: Accomplished. 2.14 Strengthen Bapepam-LK to: stock exchange (i) monitor the (i) Monitor the implementation of the merger Following approval of the Capital Market governance. implementation of between JSX and SSX Law, undertake diversification of ownership. the merger Agency: Bapepam-LK agreement between Status: Accomplished JSX and SSX; (ii) Finalize framework for the establishment of Bapepam-LK will promote and license (ii) allow merged alternative trading system/electronic alternative trading system/electronic exchange to communication network and include in provisions communication network as appropriate. implement strategy to the draft amendment to the Capital Markets Law. for broadening Agency: Bapepam-LK ownership and strengthening Status: Accomplished. governance; (iii) Include provisions in draft Capital Markets Law (iii) provide a framework to allow for merged exchange to implement strategy for broadening ownership and for the establishment strengthening governance. of alternative trading system/electronic Agency: Bapepam-LK A 4 ppendix communication Status: Accomplished. network. 2.15 New Action. Issue rules strengthening SRO’s governance via Bapepam-LK will monitor the governance of establishing minimum criteria for board of exchange and adopt the minimum criteria for commissioners and board of directors. board of commissioners and board of 55
56
Appendix 4 Appendix No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011
Agency:, Bapepam-LK directors as appropriate. Status: Accomplished. 2.16 New Action. Enhance market surveillance system incorporating KSEI to build on investor area facility and investor area facility from KSEI. incorporate individual investor identification Agency: KSEI through unique id number. Status: Accomplished. 2.17 New Action. Exchange to establish and operationalize new trading system Agency: IDX Status: Accomplished. 2.18 Promote more MOF to submit to Parliament (i) MOF to submit to Parliament relevant (i) Upon passage of revised tax law by conducive tax relevant amendments to tax laws amendments to tax laws to address tax Parliament, DG Tax to consider removal of environment for to address tax disincentives in disincentives in Shariah-based products. VAT on transfer of assets from originator to capital markets Shariah-based products. a special purpose vehicle for securitization Agency: DG Tax, MOF; Bapepam-LK development. purposes through a Government decree. Status: Accomplished. (ii) Government to study and consider full (ii) Bapepam-LK submits case for full application of EET (exempt- exempt- taxable) tax treatment for application of EET (exempt- exempt- taxable) tax treatment for pension funds Government to study and pension funds on investment portfolio. on investment portfolio. Bapepam-LK to consider full application of EET Agency: DG Tax, MOF; Bapepam-LK coordinate with DG Tax to allow for (exempt- exempt- taxable) tax Status: Accomplished amendment of MOF decree to allow treatment for pension funds. exemptions to take effect by 31 December 2009. New Actions. (iii) DG Tax to remove distortions and preferential Maintain EET treatment of pension funds. treatment for mutual funds on income derived from Maintain system free of tax distortions on fixed-income securities. financial products Agency: DG Tax, MOF Status: Accomplished. (iv) DG Tax to provide incentives to listed companies. Agency: DG Tax, MOF Maintain tax incentives for listed firms. Status: Accomplished. (3) Improving market surveillance and market protection
No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011 3.1 Strengthen MOF to implement the Joint task force set up comprising senior officials Study completed by December 2009 autonomy, amendments to the regulatory from BI/Bapepam-LK and study initiated on deciding appropriate structure. accountability, framework to enhance Bapepam- alternative options for arriving at appropriate Enabling provisions on recommended and regulatory LK’s financial autonomy and integrated regulator structure for the financial structure submitted to competent powers of strengthen powers sector. authority for approval in 2010. Bapepam- Bapepam-LK. Agency: Bapepam-LK LK empowered with financial autonomy Status: Accomplished. and strengthened powers by December 2010 3.2 MOF to submit draft amendments Draft amendments to the capital market, pension Draft amendments of three sector laws to the three sector laws (capital and insurance laws completed and socialization submitted to President by April 2010. market, pension and insurance) process initiated Submitted for Parliamentary to achieve greater compliance Agency:, Bapepam-LK consideration later in 2010 with international best practices Status: Accomplished. and principles (IOSCO, IAIS and OECD), to Parliament (was initially deferred to first allow Parliamentary consideration of OJK Law. Now the study initiated under 3.1 above, the three sector laws will be finalized and submitted 3.3 New action. Initiate development of Capital Market Master Plan Capital Market Master Plan (2010-2014) (2010-2014). completed and adopted by December Agency: Bapepam-LK 2009. Status: Accomplished. 3.4 Promote Bapepam-LK to develop and Establish a special task force with members drawn Bapepam-LK to join Schedule A of IOSCO regional implement IOSCO MMoU action from relevant bureaus to assess obstacles to MMOU and develop and implement cooperation. plan. joining Schedule A of IOSCO MMOU. related action plan. Agency: Bapepam-LK Status: Accomplished. A
3.5 New Action. IDX to enter into bilateral MOUs (drafted by Bapepam-LK to: (a) circulate code of 4 ppendix Indonesia) with 5 other participating ASEAN conduct of its SROs and capital market exchanges as part of regional commitment to set participants to the other securities up ASEAN Trading board (which involves 30 regulators in ACMF, to allow countries to stocks from each participating stock exchange from better harmonize codes, (b) work towards
ASEAN implemented through common exchange achieving ASEAN Plus standards, (c) 57
58
Appendix 4 Appendix No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011
gateway). incorporate regional integration issues in Agency: Bapepam-LK and IDX its National Capital Market Master Plan, Status: Accomplished. and (d) develop dispute resolution mechanisms and circulate to ACMF members. 3.6 Enhance risk- Bapepam-LK to update risk- Bapepam-LK to enhance risk-based supervision of based based parameters and minimum contractual savings industry, by: supervision of capital requirements in line with (i) requiring increase in minimum equity through Insurance Bureau to monitor implementation contractual international best practices. Government regulations for both life and non-life and take appropriate action, as required, to savings insurance companies from Rp 40 billion by end- ensure enhanced insurance services from industry. 2010 to Rp 100 billion by end-2014 and from Rp the consolidation undertaking. 100 billion by end-2010 to Rp 200 billion by end- 2014 for reinsurance companies.
Agency:, Bapepam-LK
Status: Accomplished.
(ii) updating risk-based parameters for insurance
companies based on actuarial data
Agency: Bapepam-LK
Status: Accomplished. Bapepam-LK to implement risk- (iii) implementing risk-based supervision of pension based supervision of pension funds; and Pension Bureau to complete the funds. implementation of risk-based supervision to Agency: Bapepam-LK the pension industry. Status: Accomplished
(iv) developing monitoring indicators to support New Action. risk-based supervision of insurance companies.
Agency: Insurance Bureau, Bapepam-LK Status: Accomplished. 3.7 Strengthen Bapepam-LK/Exchange to Bapepam-LK/Exchange to develop an Bapepam-LK in conjunction with SROs to investor develop an implementation plan implementation plan for a securities-market implement the plan for securities-market protection. for a securities-market investor investor protection fund. investor protection fund from 2010 to protection fund. Agency: Bapepam-LK and IDX. 2012. Status: Accomplished. 3.8 Bapepam-LK to establish facility Establish a public complaints management system. Bapepam-LK to build on public complaints
No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011 to allow for submission, Agency: Bapepam-LK management system to identify/provide early monitoring, and addressing of Status: Accomplished. warning of areas of potential concern. investor complaints. 3.9 Bapepam-LK to issue rules and Issue rules and guidelines on asset valuation and guidelines on asset valuation and disclosure rules on asset valuation and require the disclosure rules on asset prospectus for each investment fund disclose the valuation and require the valuation method that will be used. prospectus for each investment Agency: Bapepam-LK fund disclose the valuation Status: Accomplished. method that will be used. Bapepam-LK to: (i) issue rules The Bond Pricing Agency is fully operational and Bapepam-LK to issue rules and and guidelines for fund managers the pricing information issued by BPA is guidelines for fund managers to utilize to utilize the independent considered reliable; the independent valuation provided by valuation provided by licensed (i) Monitor implementation of NAV calculations and licensed Bond Pricing Agency. Bond Pricing Agency; (ii) Monitor disclosure. implementation of NAV Agency:, Bapepam-LK calculations and disclosure. Status: Accomplished.
(ii) Review effectiveness of implementation of rules Bapepam-LK to issue rule requiring Bapepam-LK to review concerning mutual fund sales agents and sales appointment of compliance officer for effectiveness of implementation agent representatives. investment management companies to, of rules concerning mutual fund Agency: Investment Management Bureau, among other things, strengthen sales agents and sales agent Bapepam-LK accountability by sales agents and sales representatives. Status: Accomplished. agent representatives.
(4) Strengthening governance and human resource capacity 4.1 Strengthen FSSF to develop Indonesian BI and MOF to commit to undertake Financial FSAP to be completed by May 2010. overall financial financial system architecture and Sector Assessment Program (FSAP) evaluation Government to make FSAP findings public sector risk- financial sector early warning (with IMF and World Bank) to allow for and implement recommendations. management system. comprehensive and up-to-date diagnostic of A
though better financial sector vulnerabilities. 4 ppendix coordination. Agency: Bank Indonesia and MOF. Status: Accomplished. 4.2 (i) Bapepam-LK and Indonesian Strengthen anti-money laundering regime, through:
Financial Transaction Reports (i) initiation and conduct of ongoing AML 59
60
Appendix 4 Appendix No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011
and Analysis Centre (PPATK) to awareness raising and training program for PPATK in collaboration with Bapepam-LK to work with industry associations to regulated entities in nonbank financial sector to develop and implement action plan to develop systematic capacity- strengthen capacity to comply with AML-related address AML-related vulnerabilities in building approach for nonbank responsibilities. nonbank financial sector identified by APG financial institutions to improve Agency: PPATK and Bapepam-LK mutual evaluation. compliance with AML regulations. Status: Accomplished. (ii) Bapepam-LK to develop and implement procedures and (ii) conduct of AML compliance audits of regulated strengthen capacity for effective entities in nonbank financial sector; and supervision of AML regulations. Agency: PPATK (iii) PPATK to prepare amendments to the AML law to Status: Accomplished. comply with revised FATF 40+9 (iii) introduction of criminal sanctions for non- recommendations and provide for compliance by regulated entities with AML PPATK to cooperatively support the training reorganization of PPATK, and responsibilities; and development capabilities of Bapepam- confer upon it additional Agency: PPATK LK’s enforcement staff through staff powers—including the ability to Status: Accomplished. secondment to PPATK and ongoing conduct preliminary investigative assistance to Bapepam-LK investigations. enforcement staff. 4.3 Enhance Bapepam-LK research and Conduct ongoing specialized internal and external Bapepam-LK to conduct specialized internal industry skills training fully operational. training to strengthen capacity across a range of and external training to strengthen capacity and capacity for functional areas as well as research bureau. across a range of functional areas as well as capital markets Agency: Bapepam-LK research bureau. and contractual Status: Accomplished and ongoing. savings. 4.4 Bapepam-LK to be developing Capital Markets Institute (CMI) initiated IDX, KPEI, KSEI, UI, and Bapepam-LK to collaborative programs with cooperatively by IDX, KPEI, KSEI, UI, and fully develop a self-managed CMI as a universities. Bapepam-LK to provide a focus for undergraduate, focus for capital markets education in graduate, and professional training to develop the Indonesia. capital markets. Agency: Bapepam-LK; IDX; KPEI; KSEI; UI Status: Accomplished. 4.5 MOF to commit incremental MOF to commit incremental expenditures for MOF to continue to fund the needed staff expenditures for capacity capacity development in the area of capital development of regulatory staff. development in the area of markets and NBFI line with medium term program.
No. Purpose Original indicative action as Completed action and responsible agency Post-Program Monitoring Framework1 agreed in 2007 September 2009 – June 2011 capital markets and NBFI line Bapepam-LK to pursue allocation of committed with medium term program. budgetary allocation under Subprogram 1 MOF. Agency: Secretariat, Bapepam-LK Status: Accomplished. 4.6 New Action. Bapepam-LK to develop a database and user-friendly website to provide consolidated capital markets and NBFIs information in appropriate presentations available both for domestic (Bahasa Indonesia) and international audiences (English)
ACMF= ASEAN Capital Markets Forum, APG =Asia Pacific Group, BPA = bond pricing agency, CMI = Capital Markets Institute, DG DM = Directorate General Debt Management, DG Tax = Directorate General Tax, EET = exempt-exempt-taxable, ETF =Exchange Traded Fund, FSAP = Financial Sector Assessment Program, GMRA = Global Master Repurchase Agreement, IAA = Indonesian Accounting Association, IAIS= International Association of Insurance Supervisors, IDX = Indonesia Stock Exchange, IFRS = International Financial Reporting Standards, IOSCO = International Organization of Securities Commissions, JSX = Jakarta Stock Exchange, KPEI = Indonesian Clearing and Guarantee Corporation, KSEI = Indonesian Central Securities Depository, MRA = Master Repurchase Agreement, NBFI = Nonbank Financial Institutions, OECD = Organization for Economic Co-Operation and Development, PPATK = Financial Transaction Reports and Analysis Center, PT SMF = PT Sarana Multigriya Finansial (Secondary Mortgage Corporation), REIT = Real Estate Investment Trust, SJSN = Social Security System, SSX = Surabaya Stock Exchange; SRO = self-regulatory organization, UI – University of Indonesia,
A ppendix 4 ppendix 61
62 Appendix 4
Appendix 4 63
64 Appendix 4
Appendix 4 65
66 Appendix 4
Appendix 5 67
LIST OF INELIGIBLE ITEMS
1. Loan proceed will finance the foreign currency expenditures for the reasonable cost of imported goods required during the Capital Market Development Program loan.
2. No withdrawals will be made for the following:
(i) expenditures for goods included in the following groups or subgroups of the United Nations Standard International Trade Classification, Revision 3 (SITC, Rev. 3) or any successor groups or subgroups under future revisions to the SITC, as designated by the Asian Development Bank (ADB) by notice to the Borrower:
Table A5: Ineligible Items
Chapter Heading Description of Items 112 Alcoholic beverages 121 Tobacco, unmanufactured; tobacco refuse 122 Tobacco, manufactured (whether or not containing tobacco substitute 525 Radioactive and associated materials 667 Pearls, precious and semiprecious stones, unworked or worked 718 718.7 Nuclear reactors, and parts thereof, fuel elements (cartridges), nonirradiated for nuclear reactors 728 728.43 Tobacco processing machinery 897 897.3 Jewelry of gold, silver or platinum-group metals (except watches and watch cases) and goldsmiths’ or silversmiths’ wares (including set gems) 971 Gold, nonmonetary (excluding gold ore and concentrates) Source: United Nations.
(ii) expenditures in the currency of the Borrower or of goods supplied from the territory of the Borrower; (iii) expenditures for goods supplied under a contract that any national or international financing institution or agency will have financed or has agreed to finance, including any contract financed under any loan or grant from the ADB; (iv) expenditures for goods intended for a military or paramilitary purpose or for luxury consumption; (v) expenditures for narcotics; (vi) expenditures for environmentally hazardous goods, the manufacture, use or import of which is prohibited under the laws of the Borrower or international agreements to which the Borrower is a party, and any other goods designated as environmentally hazardous by agreement between the Borrower and ADB]; and (vii) expenditures on account of any payment prohibited by the Borrower in compliance with a decision of the United Nations Security Council taken under Chapter VII of the Charter of the United Nations.
68 Appendix 6
SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY
Country and Project Title: Indonesia –Capital Market Development Program Cluster -Subprogram 2
Southeast Asia Lending/Financing Department/ Department/Financial Sector, Policy-Based Modality: Division: Public Management and Trade Division
I. POVERTY ANALYSIS AND STRATEGY A. Link to the National Poverty Reduction Strategy and Country Partnership Strategy
Before the Asian financial crisis, Indonesia had been successful in reducing poverty, with rates in terms of the population living below $1 per day dropping from more than 50% in 1970 to 16% in 1996. However, at the peak of the crisis in 1998, the poverty incidence reached 24%. Although it has been steadily falling since then, poverty remains persistent in Indonesia. Recent surveys suggest that about half of the population still lives below the $2 per day poverty line. Continued economic growth has lifted living standards; however, the benefits of economic growth are not equally distributed among the population. Rural poverty is significantly higher that urban poverty, with about 60% of the country’s poor living in rural areas. Causes of both urban and rural poverty include absence of economic opportunities, lack of access to key social services, and poor infrastructure.
The medium-term national development plan, 2004–2009a provides a clear set of targets that the Government wants to achieve by the end of the period. Among them are sustained growth of more than 6%, job creation to absorb 1.5 million new entrants into the labor market annually, achievement of Millennium Development Goal targets, and a reduction in the stock of debt to 31.8% of gross domestic product. The medium-term development plan sets out a good policy framework for the reforms and investments needed for each sector. Some adjustment in growth rates for 2009 and 2010 is now acknowledged because of the impact of the global crisis. After growing more than 6% in 2007 and 2008, the economic growth is expected to slow to 3.5% in 2009, before recovering to about 5% in 2010. Policies envisaged under the Government’s medium-term macroeconomic framework aimed to help mitigate economic vulnerabilities, improve the business climate, and encourage investment. Therefore, the Government is placing a high priority on continuing reforms in investment procedures and regulations, customs and trade facilitation, and labor regulation, as well as dedicated actions aimed at improving infrastructure and strengthening the financial sector to support a sound investment climate. To support faster economic growth and poverty reduction, the Program supports the Government’s development agenda to establish Indonesia's capital market as a resilient and competitive market that supports higher growth for the national economy. The Program will provide a policy framework that encourages financial innovation in terms of new instruments and tenors, and new kinds of intermediation.
The Program supports the achievement of the medium-term reform agenda's economic growth and poverty reduction targets. It is also included in the Asian Development Bank’s overall strategy, which sees capital market and financial sector reforms as a key area of engagement to address poverty and regional disparities, and to achieve the Millennium Development Goals for development. B. Poverty Analysis Targeting Classification: General Intervention 1. Key Issues About half of Indonesia's 235 million people are considered poor and survive on less than $2 a day; about 18% live on $1 or less. In addition, a significant portion of Indonesia's population has an income that is just above the poverty line. A large proportion of vulnerable people are at risk of falling into poverty because of accelerating inflation caused by increases in food and oil prices, and the impacts of natural disasters. Poverty-related challenges in Indonesia are not only the large number of poor but also the striking disparities between regions, provinces, districts, and cities. Poverty is expected to increase in 2009 because of the global financial crisis. In response, the Government aims to increase development and social spending in 2009. The additional funding is needed to mitigate the substantial negative effects on Indonesia's economy, and especially on the poor, of the
Appendix 6 69 deep and possibly protracted economic recessions in Indonesia's major trading partners. Based on the experience gained from the Asian crisis 1997–1998, the Government placed the task of reassuring financial markets at the top of its crisis response agenda. Aware of how important it is for the overall economic prospects of Indonesia during the crisis to maintain financial market confidence, the Government undertook several policy actions to soften the impact of the crisis on the vulnerable population.
2. Design Features. The Government's medium-term reform agenda includes financial sector development with capital market development as one of the core elements. Over the longer term, these reforms will increase Indonesia's reliance on domestic financial markets for meeting its investment needs. The impact of the Program will be greater financial sector diversification and resilience. The Program is embedded in the Government's medium-term reform agenda. The outcome of the Program is sufficient capital market growth to enable more diversification of markets combined with stronger regulatory and supervisory capacity to ensure resilience of the financial sector as well as the economy. The Program is expected to lead to an increase in the nonbank financial sector’s share of total financial assets. The Program supports the Government’s development agenda to establish the Indonesian capital market as a resilient and competitive market that supports faster growth for the national economy. C. Poverty Impact Analysis for Policy-Based Lending Despite recent signs of progress, Indonesia lags its more prosperous neighbors in producing higher value-added nonagricultural jobs. Job growth has failed to match population growth since the Asian crisis, and job creation in the formal sector has been especially sluggish. Though the open unemployment rate has fallen since its peak of 11.2% in 2005 to 9.1% in 2007, unemployment remains high, especially among youth. Of greatest concern is that, as of 2008, more than 40% of Indonesia’s labor force still derived its livelihood from low-productivity activities in agriculture and related areas, while only 30% of Indonesia’s growing labor force appears to have made the transition to what are considered high value-added activities. The country’s authorities understand that the central challenges Indonesia faces in realizing its development agenda are all, in one form or another, institutional. Development and sustainability of the financial sector through market-based reforms remain high on Indonesia's reform agenda.
Capital market development contributes to poverty reduction in Indonesia. Against this backdrop, the Program will help Indonesia adopt measures that would lead to broader access to financial services and a more competitive and diversified financial sector that reduces systemic vulnerability and meets the immediate funding needs of the economy. It will lead to enhanced market-based financial intermediation, more efficiency and outreach of financial services and products, and stronger key institutions and human resources for the financial sector. Overall, the Program will lead to a more balanced and competitive financial structure, increase income and employment-generation, reduce income fluctuation of individuals and businesses, and contribute to macroeconomic stability and poverty reduction. II. SOCIAL ANALYSIS AND STRATEGY A. Findings of Social Analysis Key Issues. No direct issues. The budgetary support through the Program will help the Government stimulate long-term economic growth and competitiveness.
B. Consultation and Participation The Program is part of the Government's broad reform agenda and is anchored in the Government's comprehensive financial sector reform and policy measures. It was designed through a participatory process involving major government and nongovernment stakeholders at the national level, and development partners. Participation took place through regular consultations. During its implementation, broad stakeholder participation has been maintained. The Government is strongly committed to developing the capital markets through the Capital Market Master Plan (CMMP) and the Financial Sector Policy Package (FSPP). The initiatives represent a combination of economic, business, legal, and regulatory factors designed to enhance the role of the Indonesian capital market as an engine of economic growth. The Program supports qualitative changes to processes to ensure effective implementation. It focuses on outcomes and allows for greater flexibility in actions necessary to achieve compliance. It is predicated on the need for a policy and institutional response to significant market developments since the completion of the subprogram 1. This will help to create deeper and more liquid capital markets. At the same time, the Program will promote stronger intermediaries that are better able to mobilize and
70 Appendix 6
allocate resources and risks. Better market surveillance and investor protection will promote stability and resilience, and are essential for capital market development. To maintain the momentum in reforms, the Government proposes to have in place the CMMP for 2010–2015 developed and implemented through ADB technical assistance. Together with broader economic reforms in Indonesia, the reform of capital markets will contribute to productivity growth, employment generation, and financial sector stability 2. What level of consultation and participation (C&P) is envisaged during the project implementation and monitoring? Information sharing Consultation Collaborative decision making Empowerment
3. Was a C&P plan prepared? Yes No C. Gender and Development Key Issues. None No direct gender issues, in relation to promoting gender equity and/or women's empowerment, have been identified. However, enterprises owned by women (large to medium-sized) are also expected to benefit from broader access to the products and services offered by the capital markets. III. SOCIAL SAFEGUARD ISSUES AND OTHER SOCIAL RISKS Issue Significant/Limited/ Strategy to Address Plan or Other Measures No Impact Issue Included in Design No impact None Full Plan Involuntary Short Plan Resettlement Resettlement Framework No Action No impact None Plan Indigenous Peoples Other Action Indigenous Peoples Framework No Action Labor The impact on labor is None Plan Employment positive through Other Action opportunities improvement in the No Action Labor retrenchment investment climate and Core labor standards broader access to capital for companies. Affordability The costs of services Action provided by the capital No Action markets are expected to be rationalized and to be competitive. Other Risks and/or Vulnerabilities Plan HIV/AIDS Other Action Human trafficking No Action Others (conflict, Political instability, etc), please specify
IV. MONITORING AND EVALUATION Are social indicators included in the design and monitoring framework to facilitate monitoring of social development activities and/or social impacts during project implementation? □ No a Presidential Regulation 7/2005 on the Medium-Term National Development Plan, issued on 19 January 2005.
Appendix 7 71
ENVIRONMENTAL ASSESSMENT OF THE POLICY MATRIX
A. Introduction
1. The Capital Market Development Program Cluster (CMDPC) supports the Government’s reform agenda for the financial sector. The policy measures include a set of reforms to promote the diversification of financial channels by enhancing the growth and development of the capital markets. The CMDPC has two subprograms. ADB approved a single-tranche loan of $300 million under subprogram 1 (2006–2007) of the cluster in December 2007. Subprogram 2 covers the period October 2007–August 2009. This environmental assessment report examines the environmental impacts of the policy component of the subprogram 2.
B. Description of the Policy Interventions
2. The reform agenda is structured around the following policy outcomes, which form the basis of the four components for the proposed CMDPC: (i) enhancing information disclosure and price discovery, (ii) promoting deeper and more liquid financial markets, (iii) improving market surveillance and investor protection, and (iv) strengthening governance and human resource capacity.
3. The CMDPC is embedded in the Government’s medium-term reform agenda, and the two-tranche structure will provide the Government with the flexibility to adjust the Program and its speed of implementation according to country developments.
Table A8: Environmental Assessment of the Policy Interventions
Policy Area Economic and Social Environmental Mitigation Outcome Impact Measures 1. Enhanced information disclosure and improved price discovery Reduction in bid/offer spreads None None needed for bonds 2. Deeper and more liquid financial markets Benchmark for 3-, 5-, 7-, 10- None None needed 15-, and 20-year bonds created through domestic debt swaps and/or consolidation
Treasury bills issued for None maturities ranging from 12 months down to 1 month
Increase in market None capitalization by 50% by 2012
A doubling of the number of individual holders of market None securities, equity, and government bonds, including through mutual funds from 2007–2012
Increase in number of listed companies by 15% to 450 None
72 Appendix 7
Policy Area Economic and Social Environmental Mitigation Outcome Impact Measures
Percentage of IPOs to market capitalization increased by None 1.5%–2% per year
Increased number of new products issued None 3. Improved market surveillance and investor protection Increased compliance with None None needed IOSCO principles Under the Program, Investor protection fund set up ADB funds will not be in 2010–2012 used to finance investments in Jakarta Stock Exchange infrastructure, or and Surabaya Stock used as a financial Exchange merged in 2008 intermediary to channel ADB funds to infrastructure projects. 4. Improved governance and human resource capacity in market institutions Stronger insurance companies None None needed with increase in capital and full implementation of risk-based capital framework
Regulation and rules issued to strengthen "know-your- customer" ADB = Asian Development Bank, IOSCO= International Organization of Securities Commission, IPO = initial public offering.
C. Environmental Management Plan
4. An environmental management plan is not required.
D. Conclusion
5. On the basis of this assessment, the Program is classified as environment category C.