Acombination of rising fuel prices, double-digit inflation and political jockeying ahead of national elections next year is putting lenders on alert in Indonesia, the largest economy in south-east Asia. At the same time, the global rally in commodity prices is creating plenty of bankable winners and spreading wealth across the resource-rich archipelago.
For banks in Indonesia with solid balance sheets – and that applies to most of the private and state-owned lenders that emerged from the wreckage of the 1997/98 Asian meltdown – the volatility appears to be manageable.
Even with the current impact of tightening by the central bank, Bank Indonesia (BI), which raised rates again in July – the third month in a row – economists predict GDP growth in 2008 should hit 6%, not far below last year’s 6.3%. This would be sufficient to raise nominal per capita gross domestic product (GDP) above $2200 in a country of 228 million people.
Bankers are braced for a likely slowdown in consumer lending after an average 28% rise in domestic fuel prices in May, a move that had become inevitable as government subsidies had been strained by global crude prices. Such politically sensitive hikes – the last was in 2005 – typically hit retail sales, particularly of cars and motorbikes, as low-paid workers delay purchases. Many corporate borrowers focused on low-end market goods and services are likely to turn cautious too, while higher transport costs may harm some investments in Indonesia’s outer islands.
Inflation forecast
Speaking in early July, BI governor Mr Boediono told reporters that inflation had likely peaked at 11% and would trend lower in the second half of the year, settling between 6.5% and 7.5%. Many economists believe that this may be hard to achieve, given the global pressure on fuel subsidies, though another sharp rise at the petrol pumps would be highly unpopular for the ruling coalition going into parliamentary elections next April. President Susilo Bambang Yudhoyono, a moderate reformer and retired army general, will be seeking a second term at a presidential poll in July.
Across the banking sector, loan growth in the year to May rose 31%, according to BI data. During the same period, the ratio of net non-performing loans (NPLs) declined to 1.78%. Loan portfolios are certain to come under more stress, however, as fuel-led inflation feeds into the broader economy, and banks are already raising coverage ratio and adjusting loan targets.
But these pressures on assets are a far cry from the Asian crisis period, when banks were swamped by unpaid loans and foreclosed assets, says Bank Danamon deputy president director Jos Luhukay, who joined the bank in April.
During the crisis, Mr Luhukay chaired the Jakarta Initiative, a well-regarded government-sponsored taskforce put in charge of mediating billions of dollars in debt workouts for private-sector borrowers. He says there is no question that Indonesian banks have learned from the past and have overhauled their systems to guard against any loan deterioration.
“What’s different now is that we have a mature risk management system. Even for seven-day collateralised loans [that are overdue], we move on them. The waiting game is over,” says Mr Luhukay.
Lending restraint
State-owned Bank Negara Indonesia (BNI), the country’s fourth largest lender, is also exercising caution over its $9bn loan portfolio, of which about two-thirds is extended to consumers and small and medium-sized enterprises (SMEs).
Its management is using 2005 as a reference point for calculating the potential impact of fuel-led inflation on economic growth and on asset quality. After the 2005 fuel hike, BNI’s proportion of NPLs rose from 4% to 13%, pushing it well above the sector average and forcing another round of restructuring.
This means that provisioning will be highly conservative as a buffer against asset deterioration, even if it reduces profitability in the short term, says Gatot Suwondo, chief executive of BNI, which is 77% owned by the Ministry of Finance. At the same time, Mr Suwondo has set a target of raising the bank’s loan-to-deposit ratio from 60% to 70%, closer to that of its rivals.
“We have to strengthen our fundamentals first. We have to be conservative in our coverage ratio and on consumer loan growth, but we will focus on corporate loans in industries that have good prospects in the future,” says Mr Suwondo.
Among the industries that are getting the red-carpet treatment from Jakarta’s top bankers is mining, particularly companies that are exporting coal to China, Japan and other energy-dependent economies. Indonesia is the world’s largest exporter of coal, which has more than doubled in price since 2007. The country is expected to extract around 215 million tonnes of thermal coal this year, more than three-quarters of which will be shipped overseas, providing ample financing opportunities for banks.
In July, coal miner Adaro Energy rolled out a $1.3bn initial public offering, the largest ever in Indonesia, with solid demand from foreign institutional buyers. In May, another coal miner, Indika Energy, sold about $300m in shares in an offering that was 17 times oversubscribed, reflecting the strong appetite for exposure to Indonesia’s mineral assets.
The response to these equity offerings, and a steady flow of foreign direct investment into the coal sector, underscore Indonesia’s economic strengths in an era of bullish commodity prices, says Tigor Siahaan, country business manager at Citi Markets & Banking. This will pump more money into Indonesia’s mineral-rich regions beyond Java and Bali, the most developed and heavily populated islands in the archipelago. Citi played a lead role in the placement of shares in Indika.
Chasing coal deposits in Indonesia is not for the risk-averse, though. As a result of decentralisation after the fall of strongman President Suharto in 1998, district governments have asserted their right to issue permits for coal and other mining activities, allowing companies to sidestep central government licensing procedures. A mining law to set the limits for local control of minerals has been stalled in parliament for more than three years.
This means that companies are relying on new forms of mining permits that may carry some risk. “This is becoming the way of life for mining in Indonesia. But in terms of certainty and the law, it hasn’t been tested,” says Mr Siahaan.
Optimism on ipos
Along with other banks with a strong capital markets presence, Citi remains positive on Indonesia’s commodities-led growth story. The success of two closely watched mining share offerings have spurred talk of more to follow, while Indian and Chinese power companies are increasingly active in securing direct supplies of Indonesian coal.
“In every period of volatility there are opportunities. So we will be more prudent but we see many opportunities for commodity hedging and derivatives and transaction services,” says Mr Siahaan.
Nobody is discounting the downside risk from inflationary pressures and higher rates, but Indonesia seems better placed than other south-east Asian exporters to ride out the current global volatility. Even the more cautious outlook for consumer and SME loan growth may be offset by the wealth accruing from increased exports of coal, copper, palm oil, cocoa and other in-demand commodities.
“We see tremendous growth off Java. The benefits of the commodities boom in coal and palm oil, for example, are extensive,” says Eugene Galbraith, president commissioner of Bank Central Asia (BCA), a private lender that has a strong retail presence across Indonesia. Its loan portfolio stood at $9.5bn at the end of May, up from $8.9bn last December.
Compared with countries such as Malaysia and Singapore, where asset valuations have returned to or surpassed their pre-crisis level Indonesia is still held back by perceptions of political risk and a lack of legal certainty for foreign investors. Office towers in the business district around Jalan Sudirman, the modern showcase for visitors to the capital Jakarta, are worth roughly half of their value before Indonesia’s currency began its vertiginous slide in 1997, according to Mr Galbraith, who joined BCA in 2002.
Capital markets participants got a jolt of uncertainty in July when Indonesia’s capital markets regulator Bapepam issued a new set of rules for corporate acquisitions, which analysts say could penalise minority shareholders. The key change is the threshold for compulsory tender offers, which was raised from 25% to 50%. In order to prevent public companies from being taken fully private, Bapepam now requires purchasers to ensure a free float of 20% via a share placement within two years of a takeover. Bankers say they are still digesting the new rules.
Caution prevails
In general, regulators in Indonesia remain cautious on innovation in the banking sector, partly because of past abuses that exposed poor risk management systems. Banks trying to securitise mortgage assets amid a property boom in Jakarta and other cities – where pent-up demand for housing is feeding strong growth – have encountered regulatory obstacles. As a result, any companies interested in placing a real estate investment trust (Reit), a popular asset class in Asia, have had to look outside Indonesia.
“I see hesitation by the government and regulators. Because of the past crisis, regulators are still wary (of such products),” says Bank Danamon’s Mr Juhukay.
Bankers trying to expand sharia lending in Indonesia, which has the world’s largest Muslim population, got a regulatory boost in June when parliament passed a new law on sharia banking. This allows foreign ownership of such banks and clarifies the procedure for Indonesian banks wanting to spin off or convert their existing sharia lending operations.
Sharia banking is still in its infancy in Indonesia, particularly in comparison to neighbouring Malaysia, where around 12% of assets are sharia-compliant.
BNI recently inked a joint venture accord with an arm of the Islamic Development Bank, which will spin off its sharia unit. This puts BNI on par with Bank Mandiri, Bank Mega and specialist lender Bank Muamalat, which all run standalone banks. So far, the biggest challenge has been how to raise capital through sharia-compliant instruments, but that is starting to take shape with the new regulations, says BNI’s Mr Suwondo.
New rules
Consolidation was the buzzword for Bank Indonesia after the crisis as failed banks were recapitalised, merged and, in some cases, sold to foreign buyers in Asia and Europe. More equity changes have followed recently after BI insisted that foreign owners could only have a single banking presence, as a step towards rationalisation and anti-trust competition.
This ruling affected Singapore’s Temasek Holdings, which had acquired majority stakes in both Bank Danamon and Bank Internasional Indonesia. In March, Temasek agreed to sell its 56% share in BII to Malaysia’s Maybank at 4.7 times book value, a generous price that raised eyebrows in Jakarta. It remains the majority owner of Bank Danamon.
Malaysia holds controlling stakes in two other Indonesian lenders: Bank Lippo and Bank Niaga. In June, Malaysia’s government investment arm Khazanah Nasional, which owns Bumi-Commerce Bank (CIMB), agreed to merge the two, creating Indonesia’s fifth largest bank with $10.4bn in assets. The new entity will be branded CIMB Niaga, though full integration won’t be completed until end-2009.
Given the potential for more financial sector consolidation, bankers will watch the Lippo-Niaga merger closely, though some are sceptical that it heralds another round of takeovers. “Mergers are painful and if you’re not incentivised, it won’t happen,” says Mr Luhukay.
Medium-sized banks are still attracting foreign suitors. China’s ICBC bought Bank Halim last year, thereby getting a foothold in Indonesia. Other Asian lenders are said to be sniffing around for exposure to what remains a promising mass market – provided your management is up to scratch.
