Indonesia has the potential to become one of the largest economies in the world, although its growth story has often been overshadowed by China and India. Its progress since the Asian financial crisis in 1998 has included a peaceful transition to democratic elections and political stability that has underpinned the country’s rapid economic growth.
Bernard Tan, president commissioner of the Indonesian arm of DBS Bank, south-east Asia's largest financial group, compares the country's present state with the situation it was in during the crisis of the late 1990s. “If you had told me then what Indonesia would be like today, I would have called you a liar,” he says.
Shock resistance
The abundance of natural resources that lie within Indonesia and the country's demographics fuel this optimism. With a population of 240 million, Indonesia – unlike its export-dependent neighbours – has a domestic demand that has insulated it from shocks in the global economy.
UOB Indonesia projects that the country's economic growth for the fourth quarter of 2011 will reach 6.6%, and forecasts that growth of about 6% will be maintained in 2012. Looking further ahead, research from Standard Chartered states that Indonesia could become the world’s sixth largest economy by 2030.
Such expectations over Indonesia's growth are echoed by senior figures in the financial services industry. Ito Warsito, president director of the Indonesia Stock Exchange, says that during his campaign in early 2009 to be elected to his job, he pledged to improve the overall market capitalisation of the listed companies, which was just under $100bn at the end of 2008.
"I made the commitment to increase that three-fold to $300bn by 2012," says Mr Warsito. "But that was reached in 2010," he adds, saying that he made a new target of $750bn by 2015. The current overall market capitalisation is approximately $400bn.
Indirect global impact
The excitement over Indonesia’s growth story could be dampened, however, by a change in investor sentiment. Despite the country’s strong domestic consumption to buffer it from events in the global economy, there is the risk that panic could infect its capital markets. Tom Aaker, CEO of Standard Chartered Indonesia, says that the events in Europe could have an indirect effect on Indonesia, as foreign investors could pull their money out of the country.
Rating agency Moody’s also notes: “Like many emerging markets, Indonesia’s capital markets have been inundated with speculative inflows seeking higher yields. Much of this ‘hot money’ has been parked in [central bank] Bank Indonesia certificates. A sudden reversal of these funds could cause interest rates to spike.”
There was a taste of this in September 2011 when turmoil – triggered by events in Greece – hit Indonesia's financial markets, the rupiah weakened and stock and bond prices dipped. Bank Danamon of Indonesia notes that between September 8 and October 4 last year, stock prices dropped by 18.4% and foreign holdings of bonds were down by Rp37,300bn ($4bn). Between September 12 and September 29, the total net foreign sell off was Rp6500bn. During this time, Bank Indonesia aggressively supported the rupiah and bond markets, which have picked up again since October.
Investor withdrawal
One observer notes that Bank Indonesia would not have enough reserves if there was a “scorched earth” scenario from the fallout in Europe, but argues that if events in the global economy were to deteriorate further, Indonesia would be affected less badly than other markets. This reflects the two views on the impact of events in Europe: that foreign investors could retreat from Indonesia, or that they will recognise the potential when compared with the investment opportunities elsewhere.
When asked whether the crisis in the eurozone will panic investors into leaving Indonesia, or instead encourage them to invest, Mr Warsito says he believes the latter. "To reach that stage, though, we have to go through the first stage of investors withdrawing," he says, adding that he believes that they will come back. "I believe Indonesia is the best place for their money," he says.
Many in the Indonesian financial services industry share this optimism and visitors are often converted into believers when presented with the country’s growth story. However, there are voices of caution that temper the optimism. Anton Gunawan, chief economist at Bank Danamon, questions the government’s ability to respond quickly and provide a stimulus to support the economy if there was a crisis in Indonesia. "The government does not have the money for a comprehensive social security system. It could only provide some ad hoc social security nets for the poorest people," he says.
While much attention has been paid to Indonesia’s growth, it could be argued that the country’s strengths are not the result of government policy or design. “The quality of the growth is questionable, despite declining unemployment and poverty levels,” says Mr Gunawan, adding that while the country has a lot of potential, the government has a number of challenges. These include a large informal economy and low tax revenue, a high level of under-employment and a high poverty level.
Indonesia’s advantage is its demographic dividend; it has the fourth largest population in the world and Bank Danamon estimates that 70% of the population is of working age. However, 28.6% of the labour force is working fewer than 35 hours a week and an estimated 66% of workers are in informal labour.
Infrastructure issues
However, it is Indonesia’s infrastructure that is often cited as the country’s biggest weakness. Indonesia has so many islands that it is a dizzying task just to count them. Standard Chartered research puts the figure at 13,466 and notes that the archipelago stretches further than the distance between London and Moscow.
Approximately 60% of the population live on the island of Java and, as capital city Jakarta's notorious traffic jams demonstrate, its large urban areas are creaking under the weight of their populations. Standard Chartered describes the island of Java as the “domestic market story” of Indonesia, while the outer islands are the “commodity story”. Aside from the need for roads, bridges and railways to ease the congestion on Java, the country needs to build seaports and airports to facilitate the growth of its commodities trade.
These poor logistics are creating a high-cost economy. A Bank Danamon report states that it costs $600 to ship a container from Padang, in West Sumatra, to Jakarta, but only $185 to ship it from Jakarta to Singapore. “It is cheaper to ship mandarins to Jakarta from China than from Pontianak in West Kalimantan,” the report notes, adding that the price of cement in the island of Papua is 20 times more expensive than in Jakarta because of the shipping costs. "We all realise that it is badly needed," says Armand Arief, president director of PT Bank UOB Indonesia, on the country's need for better infrastructure.
Mr Warsito says of the infrastructure: "That problem does not provide us with downside risk, only upside risk." Mr Aaker at Standard Chartered agrees with this view and adds: “The story of Indonesia’s growth is bright and successful, and could be even better.” His bank’s research also states that the poor infrastructure is hindering further growth: “Unless infrastructure conditions improve, it is still difficult for Indonesia to enjoy higher than 7% economic growth rate.” Mr Aaker argues that the lack of progress in developing infrastructure is not because of investor appetite. "It is not because of a lack of financing," he says.
Stalling bureaucracy
Observers comment on the Indonesian government’s inefficient bureaucracy that has hindered further development. One issue that has held up infrastructure projects is clearing the land to make way for the building of roads, as the government has not had mechanisms to acquire land to make the projects possible. "If the bureaucratic problems are solved then the funding will follow; it is easy to find funders," says Mr Warsito.
Another hindrance to Indonesia’s development is corruption, which many argue will take more than a generation to weed out. The country has been plagued by scandals, which in recent years have been addressed by the Corruption Eradication Commission – known locally as the KPK – in its pursuit of corrupt officials. The commission has been aggressive in its investigations, which has led some to argue that it is the fear of being dragged into corruption allegations that has held up infrastructure projects as nobody wants to be accused of awarding business to their cronies.
On the question of whether worries about being accused of corruption are causing a paralysis in infrastructure projects, Mr Arief at UOB Indonesia does not agree. He says that it is only corrupt people that have anything to fear. Rather than corruption – or the fear of being associated with it – being the main hindrance, Mr Arief argues it is the land clearance issue that poses a significant hurdle to further development of the country's infrastructure.
Mr Warsito says that corruption is a problem, but when asked about whether infrastructure projects were held up because of the fear of being associated with corruption, he says: "If the project officials play by the book, this is not a problem. The paralysis is not because of the fear of being associated with corruption but because there is no punishment for doing nothing in the bureaucracy."
Tapping the potential
Despite these drawbacks about doing business in Indonesia, the banking industry is positive about the country’s growth and opportunities in the financial services sector. The banking industry is very much part of the economic growth story, with each of the country's banks carving out their own strategy to tap Indonesia’s potential.
Zulkifli Zaini, president director and CEO of Bank Mandiri, says that his bank's strategy is to simply follow the country's growth. "We want to facilitate Indonesia's business growth outside Indonesia as well as the domestic growth," he says.
Mr Zaini explains that Bank Mandiri plans to develop in both the corporate banking segment as well as in retail banking segment. Over the past six years, he adds, the state-owned bank has transformed itself into a universal bank that is more commercially minded. "We moved from a spirit of 'business as usual' to a more aggressive, sales-oriented culture. Maybe our customers have already forgotten that we are still a state-owned bank," he says.
A large proportion of the Indonesian population has still not been captured by the financial services industry, both in terms of individuals and small businesses. Vera Eve Lim, chief financial officer at Bank Danamon, says that the penetration of banking services in the population is low in Indonesia, as is the loan-to-gross domestic product ratio.
Anecdotally, industry executives comment that it is not unusual for people to buy property upfront without taking a mortgage or for small businesses owners to use their own money for funding rather than take a bank loan.
Consumer opportunities
Indonesia's rising middle class also presents opportunities to develop consumer credit and fuel the growing appetite for consumer goods. Commenting on the country’s domestic consumption, Mr Tan at DBS Indonesia says: “White goods were luxuries; now they are seen as necessities.”
While DBS Indonesia is focused on being a wealth management bank, Mr Tan points out that other banks, especially those with a wider distribution network, are pursuing opportunities in the consumer space.
A lack of a distribution network has in part influenced the strategy of the international banks in Indonesia. Mr Aaker explains that Standard Chartered Indonesia's focus is on wholesale banking for large local companies, financial institutions and multinationals doing business in Indonesia. "We are starting with the biggest names and working down," he says. In the consumer business, Standard Chartered targets high-net-worth individuals, a strategy that lends itself to its limited branch network. While Standard Chartered Indonesia does not target the mass retail and small and medium-sized enterprise (SME) market, the bank at a group level holds a 44.505% stake in PermataBank, a local bank that does.
Amanda Murphy, Head of Corporate Banking for HSBC Indonesia, explains that the bank seeks the business of companies in the middle and upper segment, which are typically large Indonesian companies that have international operations. She explains that the banking needs of these clients have become increasingly complex. “It is as sophisticated as anything you would see in London or Hong Kong,” she says.
SME target
Like Standard Chartered, HSBC Group has a shareholding in a local Indonesian bank, which has a wider branch network and targets the middle market and small and medium-sized enterprises (SMEs). HSBC Group completed its acquisition of Bank Ekonomi in 2009 and now holds a 98.96% in the Indonesian bank.
Mr Arief explains that UOB Indonesia's focus is also in the SME market. The Singaporean bank aims to be a premier bank in Indonesia and is currently developing its corporate banking business alongside strengthening its SME financing capabilities.
The definition of what constitutes an SME in Indonesia is different for the international banks and typically refers to mid-sized companies, whereas the term is used by local banks to refer to much smaller businesses. OCBC NISP, in which the Singapore’s OCBC Bank owns a 85.06% stake, focuses specifically on the SME segment, which are typically larger companies than the segment of sole traders that is targeted by the local Indonesian banks.
The lower rung
Ms Lim at Bank Danamon says that her bank identified the bottom layer of the customer pyramid as the segment that is most likely to experience the most significant growth in the Indonesian mass market. In terms of how this translates in products and services for this segment, Ms Lim says: "For business needs it is micro lending, for consumer needs it is motorcycle finance." Since 2004 Bank Danamon has embarked on a strategy of micro lending to very small business owners, which are typically market stallholders, in various islands throughout Indonesia. The bank also acquired Adira Finance, a vehicle-financing company that channels loans to the motorcycle and car industry.
State-owned Bank BRI is a domestic-oriented bank that has put its focus into micro banking and is the biggest provider of small loans in Indonesia. Aside from these micro loans, the bank provides a full range of banking services, such as savings and money transfers for migrant workers. The bank has been involved in micro lending since 1984, using the distribution network that was previously established for the government’s food security programme. It has extended its network with sub-micro outlets, which enables loan officers to have more contact on the ground at the traditional markets. The typical customer may sell rice or cooking oil and may have not had any experience of financial services before.
This model of lending is labour-intensive because the customer base needs constant monitoring and regular collections. Bank BRI has so far been able to tap this segment because of its wide distribution network, but for others to venture into the segment is viewed as risky – because of the lack of credit profile of the customers and the huge resources that are required to monitor the quality of the loan portfolio.
This, however, is the segment of Indonesia’s population that is likely to experience dramatic growth and uptake of financial products as the country continues to grow.
Approach with caution
While the local banks target the mass market, international banks are focused on their own strategy of expanding alongside their larger customers as they grow their businesses in line with the nation’s economic growth.
There are downsides to the growth story of Indonesia, but many in the banking industry point to the progress that Indonesia has made since the Asian financial crisis, which triggered the fall of the Suharto regime in 1998. In the years since, much has been accomplished in terms of bringing political stability and introducing democratic reforms. Ms Lim at Bank Danamon argues that given the diversity of ethnic groups and languages and the number of islands in the Indonesian archipelago, the progress that the country has already made is a big achievement.
Now the Indonesian population is looking ahead to the next presidential election in 2014, which Ms Murphy at HSBC describes as a “coming of age” for the country, as president Susilo Bambang Yudhoyono’s cannot be re-elected for another term. Until those elections, the current government will continue to face the challenges of responding to shocks in the global economy, improving its infrastructure and rooting out corruption. Despite these drawbacks, for most observers, the growth story of Indonesia is one of cautious optimism.
