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Bulletin of Indonesian Economic Studies

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Risks, Resilience, and Reforms: Indonesia’sFinancial System in 2019

Adam Triggs, Febrio Kacaribu & Jiao Wang

To cite this article: Adam Triggs, Febrio Kacaribu & Jiao Wang (2019) Risks, Resilience, andReforms: Indonesia’s Financial System in 2019, Bulletin of Indonesian Economic Studies, 55:1,1-27, DOI: 10.1080/00074918.2019.1592644

To link to this article: https://doi.org/10.1080/00074918.2019.1592644

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Bulletin of Indonesian Economic Studies, Vol. 55, No. 1, 2019: 1–27

ISSN 0007-4918 print/ISSN 1472-7234 online/18/0001-27 © 2019 ANU Indonesia Projecthttp://dx.doi.org/10.1080/00074918.2019.1592644

Survey of Recent Developments

RISKS, RESILIENCE, AND REFORMS: INDONESIA’S FINANCIAL SYSTEM IN 2019

AdamTriggs FebrioKacaribuThe Australian National University University of Indonesia

JiaoWangUniversity of Melbourne

Indonesiahasmanaged thecomplexchallengesof theglobaleconomywell.Thecountry’scapitaloutflowsweresmallerin2018thanduringtheTaperTantrumin2013;therupiahhadregainedmostofitslostgroundbyJanuary2019;theIndonesianstockmarkethasoutperformeditspeers;growthisforecasttoremainstable;inflationislow;unemploymentremainsbelowitsfive-yearaverage;consumerandbusinessconfidencearerobust;andthegovernmentbudgethasimprovedthroughasmallerdeficitandcheaperborrowingcosts.Butsignificantrisksremain.ThispaperassessestheserisksandevaluatestheadequacyofIndonesia’scrisismanagementframework.Itfindsthattheframeworkhasseriousdeficienciesthatcouldseeliquiditychallengesbecomesystemicsolvencycrises.TheframeworkeffectivelyremovesBankIndonesiaasthelenderoflastresort,riskspoliticisingtheprocessofcrisisresponse,andcouldmeanslower,lesseffectiveresponsestocrises.ThispaperexploreshowtheframeworkcouldbeimprovedandwhatreformscouldbeundertakentodeepenIndonesia’sfinancialsystem,strengthenfinancialresilience,andboostthelong-termgrowthoutlook.

Keywords:Indonesia, crisis management, financial markets, financial crises, government policy and regulation, banks, non-bank financial institutions, bankruptcy, financial reformJELclassification:H12,G1,G01,G18,G21,G23,G33,P11

INTRODUCTIONApopularIndonesianfolktalecharacterisSiKancil(theMouseDeer).SiKancilisatrickster.Butheisalsoasurvivor.Inhisquesttoeathisfavouritefood,cucumber,heuseshiscunning,intelligence,andwittomakehiswaythroughadangerousworld.Heavoidsbeingconsumedbycrocodiles,takenbytigers,andfilletedbyfarmers.Regardlessofthechallenge,SiKancilalwaysmanagestonavigatetheenvironment.IndonesianauthoritieshaveprobablyfeltabitlikeSiKancilinrecentmonths.The

globaleconomyhasproducedcomplexchallengesforauthoritiestonavigate,withdomesticrisksrisingandapresidentialelectionlooming.Nowisaprudenttime

2 AdamTriggs,FebrioKacaribu,andJiaoWang

toanalysetheserisks,assesstheresilienceoftheIndonesianfinancialsystem,andexplorewhatreformsneedtobeundertakentostrengthenthatresilience.TheglobaleconomycontainsmanyrisksforIndonesia.Firmsandhouseholds

thatborrowedwheninterestrateswerelowarebeingsqueezedasratesincrease.ThosethatborrowedinUSdollarsarebeingsqueezedbyastrengtheninggreenback.Thosethatborrowedthroughshort-termandportfoliolendingarebeingsqueezedbytighterfinancialconditions,bothdomesticallyandglobally.TheUnitedStates–Chinatradewarisdoingsomesqueezingofitsown.Thetrade

warescalatedthroughout2018andisnowinaholdingpattern.Itisuncertainhowandwhenitwillend.WhatiscertainisthattradeflowsandsupplychainsinAsiaaretransforming.Somecountries,suchasVietnam,appeartobebenefitingfromincreasedinvestment.Others,suchasChinaandmanyofitstradingpartners,arebeginningtofeelthecostofthetradewar(Bland2018).Thelong-termdamagetothetradingsystemwilllikelybesignificant(IMF2019).Theglobalpolicyenvironmentissimilarlyuncertain.Theprobabilityofa‘no

deal’Brexitisrising.Thefar-rightcontinuestoadvanceinEurope,Asia,andLatinAmerica.TheTrumpadministrationcontinuestoweakentheglobalrulesandinstitutionsthathaveunderpinnedmuchofAsia’sprosperity,particularlytheWTO’sdisputesettlementbody.1TheIMF’sforecastforglobalGDPgrowthin2019hasbeendowngraded,with

theweakeninggrowthofemerginganddevelopingeconomiesrepresentingthebulkofthedowngrade.Butthegrowthofadvancedeconomiescouldsoonfollow.Aflatteningyieldcurveandotherrule-of-thumbindicatorshavespurredwarningsofaUSrecessionfor2019or2020.2LimitedmonetarypolicyspacecouldseeareturntounconventionalmonetarypolicyintheUnitedStates,triggeringafreshboutoffinancialvolatilityforemergingeconomies(Economist2018).Much likeSiKancil, Indonesiahasnavigated thesechallengeswell.Capital

outflowssawtherupiahfall12%againsttheUSdollarinthe10monthstoOctober2018.ButthisfallwasfarsmallerthantheoneduringtheTaperTantrum,3 and the rupiahhadalmostcompletelybouncedbackbyJanuary2019.4Otherrecentindicatorspointtoasimilarlyrobustperformance(table1).GDP

growthfor2019isforecasttoremainsteadyat5.1%asIndonesiaapproaches20yearsofuninterruptedgrowth(IMF2019).TheIndonesianstockmarketrose10%inthe12monthstoJanuary2019,outperformingboththeS&P500andtheNikkei500,whichbothfellduringthatperiod.5InflationinJanuary2019wasatitslowestrateinmore

1.Ifcurrenttrendscontinue,theWTOdisputesettlementbodywillplungeintocrisisinDecember2019.ThebodywillnolongerbeabletohearandresolvetradedisputesunlesstheUSgovernmentsupportstheappointmentofnewjudgestoreplacethosewhosetermsareexpiring.Thusfar,however,theTrumpadministrationhasshownnodesiretodoso.2.Theserule-of-thumbindicatorsincludeaflatteningyieldcurve,ratetighteningbytheFederalReserve,aclosingoutputgap,andthestateofthebusinesscycle.SeeTriggs’(2018a)articleforadiscussionofeach.3.InthesixmonthstoJanuary2014,therupiahfell18%againsttheUSdollar.4.From1October2018to6January2019,therupiahappreciated9%againsttheUSdollar.5.TheJakartaStockExchangeCompositeIndex(JCI)rose9.8%between1January2018and6January2019.Overthesameperiod,theS&P500fell5.7%,andtheNikkei500fell15%.

Risks,Resilience,andReforms:Indonesia’sFinancialSystemin2019 3

thantwoyears,6andunemploymentremainedbelowitsfive-yearaverage.7 In late 2018,consumerandbusinessconfidenceremainedrobustbyhistoricalstandards,8 andthegovernmentbudgetimproved.Thedeficitshrankbyalmostathirdin2018,9

6.The inflationratewas2.8% in January2019, the lowestsinceAugust2016 (TradingEconomics2019).7.Theunemploymentratewas5.3%inthesecondhalfof2018.Thefive-yearaveragetoend2018is5.7%(TradingEconomics2019).8.Businessconfidencewasat108indexpointsinthethirdquarterof2018.TheaveragesinceJanuary2016is107indexpoints.Consumerconfidencewasat127indexpointsinDecember2018(TradingEconomics2019).9.ThebudgetdeficitasapercentageofGDPwas1.8%in2018,downfrom2.5%in2017and2016and2.6%in2015(TradingEconomics2019).

TABLE 1 Key Economic Indicators

Indicator

2018 2019*

March June Sep. Dec. January

GDPannualgrowthrate(%) 5.1 5.3 5.2 5.2Unemploymentrate(%) 5.1 5.1 5.3 5.3Foreigndirectinvestment ($billion)

5.2 6.2 7.0 3.6

Businessconfidence (indexpoints)

106.3 112.8 108.1 104.7

Consumerconfidence (indexpoints,quarterlyaverage)

122.1 125.1 122.9 123 125.5

ManufacturingPMI (indexpoints,quarterlyaverage)

50.6 51.2 51 50.7 49.9

Inflationrate (%,quarterlyaverage)

3.3 3.3 3.1 3.2 2.8

Retail sales (%,quarterlyaverage)

–1.5 4.4 –3.9 .7 .7

Stock market (JCI,quarterlyaverage)

6349.7 6316.3 6290.7 6303.0 6536.0

Currency (Rp:1,000USD,quarterlyaverage)

0.0734 0.0714 0.0678 0.0683 0.0771

10-yearbondyield (%,quarterlyaverage)

6.5 7 7.8 8.5 7.9

Source: TradingEconomics(2019).

Note: *Figuresarearefrommonthlydata.PMI = PurchasingManagersIndex.JCI=JakartaStockExchangeCompositeIndex.


andthecostoffinancingIndonesia’scomparativelylowgovernmentdebt10fellbyonepercentagepointafterOctober2018.11 Similarly, Indonesia’s political system appears stable, even as 190million

registeredvotersprepareforthe2019generalelectioninApril.ThepollssuggestPresidentWidodowillwincomfortably(Fealy2019),beatingthesamemanhebeatin2014,formergeneralPrabowoSubianto.Whiletheeconomyhasnotfeaturedstronglyintheextendedelectioncampaign,

therearereasonstobelievethatanincomingPrabowogovernmentcouldseeshiftsineconomicpolicy.AlthoughJokowihasbynomeansbeencommittedtomarket-basedpolicies,especiallyinagriculture,aPrabowogovernmentmayhavealess-favourableattitudetowardsIndonesia’sopennesstotherestoftheworld.Whilecampaignrhetoricmaynotnecessarilytranslateintogovernmentpolicy,Prabowohaspaintedhimselfasanationalist,implyingthatWidodoistoofriendlytoforeigners(McCawley2018).HecalledforIndonesia’shostingofthe2018IMFandWorldBankannualmeetingstobescaledbacktoredirectthemoneyelsewhere(Tempo2018).HearguedinthefirstofthefivepresidentialdebatesthatIndonesia’seconomylackedself-sufficiencyandhadbecometooreliantonforeigners(Lipson2019).Prabowo’s brother,HashimDjojohadikusumo, haswarned against foreign

investment,particularlyfromChina.AspartofPrabowo’steam,hecalledforareviewofChina’sinvolvementinaproposed$5.4billionhigh-speedraillinkbetweenJakartaandBandung(Yuniar2018).ProbowohascriticisedWidodo’seconomicperformance,claimingthatinequalityisrising 12andcitingeconomicgrowthbelow7%.Probowohaspromisedto‘saveIndonesiafromaneconomicdownturn’,althoughhehasprovidedlimiteddetailonhowhewouldachievethat(Straits Times2018).Widodo,ontheotherhand,hasfocusedmuchofhiscampaignonhisgovernment’sinvestmentininfrastructureprojects,rangingfromairportstosubways,andreducedredtape(McCawley2018).Insum,recentdevelopmentssuggestastableeconomyandastablepolitical

systeminIndonesia.Thequestionforthispaperis,willitlast?

RISKS FACING THE ECONOMY AND FINANCIAL SYSTEMDespiteIndonesia’sresiliencethroughoutadifficultperiod,risksremain.Threeareasinparticularwarrantspecialattention:financingofinfrastructurebystate-ownedenterprises(SOEs),liquidityinthebankingsector,andfinancinginthepublicandprivatebondmarkets.

10.GrosscentralgovernmentdebtinIndonesiawas29.8%ofGDPin2018,comparedtoanaverage46.9%foremergingmarketanddevelopingeconomies,47%foremerginganddevelopingeconomiesinAsia,and105.6%foradvancedeconomies(IMF2018).11.Theyieldon10-yearIndonesiangovernmentbondsrosefrom6.25%inJanuary2018to8.75%inOctober2018,thenfellto7.75%inJanuary2019(TradingEconomics2019).12.Themostrecentdata,however,suggeststhatinequalityhasfalleninIndonesia.BasedtheSusenasdata,theGinicoefficientfellfrom0.41in2014to0.38bytheendof2018.SeealsoTjoe(2018).


State-owned Enterprises and Infrastructure FinancingWidodointroducedaplanin2014forinfrastructuredevelopment.TheNationalStrategicProjects(PSN)schemeincludedtollroads,seaports,airports,powerplants,andcleanwaterprojects,costingRp4,796trillion($363billion)from2014to2019(MorrisandTsjin2015).About40%ofthefinancingfortheseprojectswastocomefromthegovernmentbudget.Theremaining60%wastocomefromSOEs,andtheprivatesector(Amin2016).In thefirst fouryearsofWidodo’s administration,however, almost all the

seaports,airports,tollroads,andpowerplantswerebuiltbySOEs.Asaresult,theSOEshavebecomeconsiderablymoreindebted.Formany,thisincreasedleverageisacauseforconcern.Shouldthesefirmsexperienceliquidityorsolvencyproblems,thiscouldquicklybecomesystemicthroughoutthefinancialsystem.WeseeavariedpicturewhenlookingintothefinancialreportsofIndonesia’s

majorSOEs,particularlythoseinvolvedintheconstructionoftollroads(table2),seaportsandairports(table3),andpowerplants(table4).ToprovidesomeinsightsintothehealthoftheseSOEs,giventheirincreasedleverage,weconsiderfourbasicmetrics:thedebt-to-equityratio(DER),thereturnonequity(ROE),thecurrentratio,andtheinterestcoverageratio.TheDERmeasurestheimportanceofdebtinthecapitalstructureofafirm.

Normally,themoreafirmborrows,thehigherthereturnonitsexistingequity.TheROEistheratiobetweenthenetincomeandtheequityofafirm.AhigherDERimpliesthatafirmusesmoredebttofinanceitsgrowth,whichexposesthefirmtoahighercreditrisk.Intheshortrun,ifthecashflowgenerateddoesnotkeepupwiththeschedulesforinterestandprincipalrepayments,liquidityproblems(i.e.,ashortageofcashorassetsthatcaneasilybeconvertedintocash)couldarise.

TABLE 2 Financial Ratios of SOEs Involved in Toll Road Construction & Management, 2014/2018

Metric

Waskita Karya PT PP

HutamaKarya AdhiKarya WijayaKarya

2014 2018 2014 2018 2014 2018 2014 2018 2014 2018

Debt (trillionRp)

3.2 61.7 14.6 48.6 5.0 40.2 10.5 28.3 3.0 14.7

Debt-to-equity ratio(%)

111.2 353.6 113.7 72.4 504.7 322.1 138.9 134.4 78.0 111.4

Returnon equity(%)

23.2 33.1 22.3 11.9 14.8 12.5 18.9 11.1 15.1 11.0

Current ratio(%)

136.2 123.5 136.9 151.7 144.9 108.2 130.2 141.2 111.9 157.1

Interest coverage ratio(%)

3.9 3.4 2.4 2.9 2.0 1.8 5.6 3.4 6.0 3.0

Sources: SOEs’ financial statements; Pefindo reports; Investing.com.


Inthelongerterm,iftheinterestexpensegrowsfasterthanthegeneratedincome,solvencybecomesaproblem.Togaugealiquidityproblem,wecanlookattheratiobetweenacompany’s

currentassetsanditscurrentliabilities;thisiscalledthecurrentratio.Thecurrentratiomeasuresthecompany’sabilitytopayitsshort-termliabilities.Aratiobelowoneimpliesthatthecompanydoesnothaveenoughliquidassetstocoveritsshort-termliabilities.Ontheotherhand,toassesstheabilityofafirmtopayinterestonitsoutstandingdebt,wecanusetheinterestcoverageratio,whichistheratiobetweenearningsbeforeinterestandtax(EBIT)andtheinterestexpense.Consideringthecompaniesinvolvedinconstructingandmanagingtollroads,

weseethatthetotaldebtofthesecompaniesincreasedbyRp157trillionduring2014–18.Atthesametime,thetotalequityincreasedbyRp103trillion,withthegovernmentinjectingmostofit.WaskitaKarya’sdebtgrewthefastest.ItsdebtofRp61.7trillioninthethirdquarterof2018wasabout19timeslargerthanin2014.ThispusheditsDERfrom111%in2014to354%in2018.TheDERofPTPP,ontheotherhand,decreasedfrom114%to72%eventhoughitsdebttripledinthesameperiod(itreceivedmostoftheequityinjectedbythegovernment).LikeWaskitaKaryaandPTPP,HutamaKaryahasbeenheavilycommissionedby

thegovernmenttobuildtollroads.AmongitsmainassignmentsistheambitiousTrans–Sumatratollroad.HutamaKarya’sDERfellfrom504.7%in2014to322%in2018eventhoughitsdebtincreasedbyeighttimes.LikePTPP,HutamaKaryahashadasizeableamountofequityinjectedintoitbythegovernment.Giventheincreaseinleverage,theprofitabilityoftheseSOEshasbeenstrong.

Quiteuniformly,theirprofitsdeclinedfrom2014to2016butimprovedin2017

TABLE 3 Financial Ratios of SOEs Involved in Airport & Seaport Construction & Management, 2014/2018

Metric

AngkasaPuraI

Angkasa PuraII Pelindo I Pelindo II Pelindo III

2014 2018 2014 2018 2014 2018 2014 2018 2014 2018

Debt (trillionRp)

5.3 11.3 3.2 11.2 1.8 3.6* 12.1 33.2* 9.5 14.4*

Debt-to-equity ratio(%)

50.6 79.9 24.9 47.1 60.2 73.5* 123.2 238.5* 132.9 131.3*

Returnon equity(%)

9.5 7.7 15.1 4.2 22.6 29.4* 16.0 18.8* 23.8 28.5*

Current ratio(%)

97.1 130.0 85.3 171.2 203.3 121.2* 156.9 468.8* 299.6 132.3*

Interest coverage ratio(%)

11.9 6.1 28.0 8.4 — — — — 17.6 6.8

Source: Companies’financialstatements.

Note: * Dataisfrom2017.


and2018.AllhadanROEbelow10%in2016,withHutamaKarya’sROEbeingtheworst,at4%.Nevertheless,theirROEsimprovedin2017and2018,andthefirmsnowenjoyROEsofabove10%,withWaskitaKarya’sROEexceeding33%in2018.Thismeansthat,ingeneral,whilethesefirmshavebecomemoreindebted,theirprofitabilityhasincreased.Moreover,thesefirmshaveacurrentratiothatisabove100%,whichsuggests

thattheyhaveagoodabilitytorepaytheirliabilitiesintheshortrun.Overthelongterm,however,mostoftheseSOEshavenotshownanysignsofsolvencyproblems.ThenextgroupofSOEstoconsiderarethoseinvolvedintheconstructionand

managementofnewairports(AngkasaPuraIandII)andnewseaports(PelindoI,II,andIII)(table3).LiketheSOEsinvolvedintheconstructionoftollroads,thesefirmshaveincreasedtheirleverageinthepastfouryears.GreaterleveragehashelpedPelindoI,II,andIIItoincreasetheirprofitability.TheROEsofAngkasaPuraIandII,ontheotherhand,havedecreasedinthepastfouryears.Despitethestronggrowthoftheairlineindustry,thefee-dependentbusinessmodeloftheairportshasresultedinaslowerincreaseintheirnetincomerelativetotheiroperationalcostsandtheadditionalinterestexpensesfromtheirhigherdebtburdens.Theshort-termliquidityofSOEsinvolvedinairportsandseaportsisgenerally

good.Interestingly,despitethehighdebtlevelsanddecreasingprofitabilityofAngkasaPuraIandII,bothhaveprudentlymanagedtheircreditriskbyincreasingtheircurrentratios.Allthefirms’interestcoverageratiosarealsorelativelyhigh,despitethesharpdeclinefrom2014to2018.StateelectricitycompanyPLNisanoutlieramongtheinfrastructure-related

SOEs(table4).ItisthebiggestSOEinIndonesia,withRp1,386trillioninassets.AlongwithstateoilandgascompanyPertamina,PLNisthemainvehicleforthe government’s energy subsidy policies.13 The government has injected asignificantamountofequityintothecompany,especiallyforthedevelopmentofits

13.SeeBurkeandKurniawati(2018)forthemostrecentdiscussionontheelectricitysectorandelectricitysubsidypolicyreforminIndonesia.

TABLE 4 Financial Ratios of Pertamina & PLN, 2014/2018

Metric

Pertamina PLN

2014 2017* 2014 2018

Debt(Rptrillion) 395.3 369.7 454.1 543.4Debt-to-equityratio(%) 169.4 114.9 296.2 64.5Returnonequity(%) 14.3 15.8 7.2 –3.0Currentratio(%) 149.1 183.6 97.6 61.7Interestcoverageratio(%) — — 0.3 0.4

Sources: Pertamina’sandPLN’sfinancialstatements.

Note: * DataforPertaminain2018wasnotavailable.


35,000-megawattpowerplant,whichwasinitiallyprojectedtobecompletedin2019.Theambitiousdeadlinewillnotbemetandwillbeextendedto2024(Amelia2019).Even though PLN has increased its borrowing in the past four years, the

government’s equity injections have been dominating the dynamics of thecompany’scapitalstructureinthepastfouryears.Thecompanysignificantlydecreaseditsleverageratioto65%in2018.However,intheshortrun,itsprofitabilityhasdeterioratedsignificantly,ithaslessliquidity,anditisstrugglingwithsolvency.Withoutanymajorgovernmentpolicyreform,PLNwilllikelycontinuedownthispath.GiventhatPLNisthemainconduitforthegovernment’senergypolicy,thisposesrisksforthegovernmentbudgetanddebtmanagement.Pertamina’s involvement ingovernment infrastructureprojectscentreson

the development of oil refineries,which comewith a substantial cost. TheconstructionoftheTubanandBontangrefineriesistocommencein2019.Theywillbefundedthroughabusiness-to-businessscheme.Meanwhile,theincreaseinoilpricesin2016–18hashelpedPertaminareduceitsdebtandpaydividendstothegovernment.14Despitethehighburdenthatcomesfromthegovernment’senergysubsidypolicy,thecompany’sprofitabilitycontinuestoincrease.Insum,mostSOEsinIndonesiahavebecomemorehighlyleveragedeventhough

theyhavereportedprofitability(partlybecauseofgovernmentassistance),withhighreturnsontheirequityandsufficientabilitytorepaytheirshort-termdebt.Thisrelianceonleveragetofinanceinfrastructurespending,however,isconcerning.15

Banking Sector LiquidityThe Indonesian banking sector is highly capitalised. The capital buffers ofIndonesianbanksfarexceedwhatiscommonintheAsiaPacificandwhatisrequiredunderBaselIII.16Atthesametime,theproportionofnon-performingloans(NPLs)hasbeenlowandisdecreasing.BoththeseindicatorssuggestthatIndonesiaenjoysasolventbankingsystem.TheNPLratioofthebankingsectorfellto2.65%inOctober2018,aftertrending

upwardfrom2013andpeakingat3%inthethirdquarterof2016.Theslightdecreasein2018waslargelyduetotherelativelystronggrowthofloans,at13.4%yearonyearthroughOctober2018,whiletheproportionofNPLsremainedfairlyconstant,ataroundRp130trillion.Lookingacrosssectors,weseenocleartrendintheproportionofNPLs,which

increasedslightlyandthendecreasedinsomesectorsbutnotothersin2014–18.Companiesinwholesaleandretailtradeandthemanufacturingindustrywerethe largestborrowersby far,owingaboutRp965 trillionandRp859 trillion,respectively,inOctober2018(figures1and2).TheNPLratiosrangedfromabout

14.AstrongerUSdollarandahigheroilpricehavehelpedthegovernment’sbudget.ThegovernmentreceivesasmuchasRp1.7trillioninadditionalnetrevenueforeachRp100ofdepreciationintherupiahagainsttheUSdollar,andanadditionalRp660billionforeach$1increaseinthecrudeoilprice(Azka2018).15.This isnot intendedtobeanexhaustiveevaluationof theperformanceofSOEsinIndonesia.ManymoreSOEsarenotcoveredinourdiscussion.TherecentsurgeintheroleofSOEsinIndonesia’seconomyisanotherissue.16.BankingstatisticsinthissectionarefromtheNovember2018editionof‘IndonesiaBankingStatistics’(OJK2018).


3%to4%inwholesaleandretailtradeandfromabout2%to3%inmanufacturingoverthefiveyears.17 TheconcernabouttheIndonesianbankingsystemnow,however,relatesto

liquidity.Thisisparticularlyproblematicforthesmaller(non-BUKU4)banks(thosewithlessthanRp30trillionincapital).18Relativelyhighdemandforloansin2018,coupledwithstrongportfoliocapitaloutflow,hasreducedliquidityinthebankingsystem.19Loan-to-depositratios(LDRs)increasedin2018,reaching93.8%inOctober2018.BUKU3banks(thosewithRp5–30trillionincapital)havebeenhitthehardest.

TheirLDRswereconsistentlyaround103%in2018.Itshouldbenoted,however,thatthehighLDRs,especiallyinBUKU3banks,havebeeninflatedbytheextremelyhighLDRsofjointventuresandforeignbanks,whichreceivefundingfromtheirparentcompanies.ButtherateatwhichLDRshavebeenincreasingisacauseforconcern.Whetherportfoliocapitalreturnsinthenearfuture,andwhethertheIndonesian

authoritiescanmaintainsufficientliquidity,willbekeytomitigatingtheriskofhighLDRs.InOctober2018,portfoliocapitalinflowsbegantoresume,20 and the inflowofforeigndirectinvestment(FDI)islikelytostabiliseatitsmedium-termlevelof$12–16billionperyear.Ifthistrendcontinues,thethreatofaliquiditycrunchwilleaseformanyIndonesianbanks.Therecentdecreasein liquidity,however,highlightsakeysusceptibilityofthebankingsystem.NowisthetimetofocusonconsolidatingIndonesia’ssmallerbanks,ensuringthattheregulatoryframeworkissufficienttoprovideemergencyliquidityintheeventofabroaderliquidityshortage.

Public and Private DebtIndonesia’sgovernmentdebtremainslow,evencomparedwithotheremergingeconomies(figure3).Thecountry’srelianceonforeign-denominatedborrowingsandshort-termborrowingshasbeenstable,whichhashelpedtoreducerisksfromcurrencyandmaturitymismatches(IMF2017).Butthehighproportionofgovernmentdebtthatisheldbyforeignerscreatesrisk,asdoestheincreaseinshort-termborrowingsbynon-financialcorporations.Intheeventofasuddenoutflowofcapital,boththesedevelopmentscouldcreatealiquidityprobleminthebankingsystem.GovernmentdebtwasRp4,400trillion($295billion)attheendofthethirdquarter

of2018(figure4).Itgrewby14.2%yearonyearcomparedwiththethirdquarterof2017.MuchofthischangewascausedbythesharpdepreciationoftherupiahagainsttheUSdollarinthesameperiod—adepreciationofalmost10%(CEIC2019).However,theratioofrupiah-denominateddebttoforeign-currency-denominated

17.Theywere lower inagricultureandconstructionandslightlyhigher thoughmorevariableintransport.18.BUKU4banksarethelargestbanksinIndonesia,andBUKU1banksarethesmallest.19.Creditgrowthreached12%(yearonyear)inOctober2018,followingabadsingle-digitperformancein2016–17.20.LPEMFEBUI(2019)indicatesa$10–12billionportfoliocapitalnetinflowfor2019.

FIGURE 2 Loans (lhs) & NPLs (rhs): Manufacturing, 2014–18

Source: OJK (2018).

2014 2015 2016 2017 20180

200

400

600

800

1,000

0

1

2

3

4

5Total loans (Rp trillion)

NPL (% of total loans)

FIGURE 1 Loans (lhs) & NPLs (rhs): Wholesale and Retail, 2014–18

Source: OJK (2018).

2014 2015 2016 2017 20180

200

400

600

800

1,000

0

1

2

3

4

5Total loans (Rp trillion)

NPL (% of total loans)


FIGURE 3 Debt-to-GDP Ratios of Selected Emerging Countries (%)

Source: IMF (2018).

Note: * Where 2018 data was unavailable, the latest data was used.

Indonesia

Turkey

Philippines

Thailan

dChina

Mexico

Malaysia

South

Africa

Vietnam

Argen

tina

IndiaBraz

il0

20

40

60

80

100

2015

2012

2018*

FIGURE 4 Central Government Debt by Currency, Q3 2014–18 (%; Rp trillion)

Source: Bank Indonesia (2018).

2014 2015 2016 2017 2018 (Q3)0

20

40

60

80

100

0

1,000

2,000

3,000

4,000

5,000

TotalDomestic currency Foreign currency



debtimprovedto58:42inthethirdquarterof2018,slightlybetterthantheratioof57:43recordedin2014(figure4).The trend for non-financial corporationswas similar. They increased their

foreign-denominatedborrowingsinthesecondhalfof2018afteravoidingforeign-denominateddebtinthefirsthalfoftheyearduetotheuncertaintycausedbythe strong depreciation of the rupiah. The interest rate differential betweenborrowinginforeigncurrencyandborrowingindomesticcurrencyhadwidenedsubstantially,21whichbroughttheratiobetweenrupiahandforeignexchangedebtto39:61(BankIndonesia2018). Thegovernmenthasconsistentlyacquiredonly3%ofitsdebtthroughshort-

term borrowing.On the other hand, non-financial corporations significantlyincreasedtheirshort-termborrowingsin2018.Theratioofshort-termtolong-termborrowingsbynon-financialcorporationsincreasedfrom13:87to19:81over2018.ThisrepresentsaRp60trillionincreaseinnewshort-termdebtinthefirstthreequartersof2018(BankIndonesia2018). Asharpwithdrawalofcapitalcouldcreateabroaderliquiditychallengeinthefinancialsystem.One of the biggest risks in the financialmarket, however, arises from the

governmentbondmarket.Around80%ofthegovernment’sdebtisintheformofsecurities.Thesearemostlymarketable,amountingtoaboutRp3,600trillionattheendof2018.InJanuary2018,41%ofthesebondswereheldbynon-residentinvestors.Thishaddroppedto37.7%bytheendof2018(LPEMFEBUI2019),butitremainshigh.Havingsuchahighproportionofgovernmentdebtheldbyforeignerscouldcreateproblemsifoutflowsofcapitalweretosuddenlyincreaseandtheforeignownersofbondsweretoselltheirassets.SuchanoutflowwouldcreateacriticalliquidityshortageinavitalmarketintheIndonesianfinancialsystemandcouldpotentiallycauseabroaderliquiditycrunchinthebankingsystem.Speedinguptheprocessoffinancialdeepeningandfinancialinclusionarecrucial

topreventsuchaliquiditycrunch.Shorttermincentives,suchasthenegativeTobintaxrecentlyimplementedbyBankIndonesia(BI)andtheMinistryofFinance,couldhelpintheshorttermbylimitingthespeedofthereversalincapitalflowsifasuddenstopoccurs.22

RESILIENCE: IS THE NEW CRISIS FRAMEWORK UP TO THE TASK?ThegovernmentpassedLaw9/2016onFinancialSystemCrisisPreventionandMitigation(PPKSK)in2016.Itspurposeistopreventandrespondtofinancialcrisesthroughbetterpreparation,andthroughcooperationbetweenIndonesia’sregulatorsandinstitutions.Thelawdelegatesresponsibilitytosevenkeyentities(figure5).

21.Theyielddifferentialbetween10-yearrupiahgovernmentbondsand10-yearUStreasurybondsincreasedfrom383basispointsinJanuary2018to553basispointsinOctober2018;thisyielddifferentialhasbeenstableataround500basispoints.22.Suddenstopshappenwhenacurrency/balance-of-paymentscrisisisaccompaniedbyareversalincapitalflows.SeeHutchisonandNoy(2006)foradiscussionofhowthiscausescurrencycrisesandoutputlossinemergingmarkets.


At thecentreof responsibilityunder the law is theFinancialSystemStabilityCommittee(KSSK).ItsroleistocoordinateanddirectIndonesia’sfourkeycrisis-responseagenciestoprevent,preparefor,andrespondtofinancialcrises(vonAllmenandKang2018).ThesefouragenciesaretheMinistryofFinance,BI,theFinancialServicesAuthority(OJK),andtheDepositInsuranceAgency(LPS).TheKSSKmeetsformallyeverythreemonths.AmajorroleoftheKSSKisto

workwithagenciestoidentifywhichbanksaresystemicallyimportanttotheIndonesianeconomy,sothattheydonotneedtobeidentifiedintheheatofacrisis(vonAllmenandKang2018).Thelawonlyappliestothesesystemicallyimportantbanksandseekstoclarifytherolesagencieswouldplayinacrisis.TheKSSKhasfacilitatedasubstantialimprovementinthesharingofinformationanddatabetweenagenciesandhashelpedincross-agencycollaboration(IMF2017).ButtheKSSKisnotjustacoordinationbody;itisalsoresponsiblefordesigningtheoverallresolutionstrategyanddirectingmemberagenciesintheimplementationofthatagreedstrategy(IMF2017).ThesecondentityunderthelawistheMinistryofFinance,whichcoordinates

theactivitiesoftheKSSK.ThelawpreventstheMinistryofFinanceoranyothergovernmentagencyfromusingpublicfundingtobailouttroubledbanks(IMF2017).Instead,thelawrequirestroubledbankstobe‘bailedin’.Abail-iniswherea failingbank’s creditorsbecomeshareholdersand the resolutionauthorities

FIGURE 5 Summary of the PPKSK Law

Source: Prepared by the authors based on consultations with Indonesian authorities and analysis by the IMF (2017).

Bank Indonesia

Liquidity advice

Coordination and direction

No public funding

Liquidity in exchange for

collateral

Declaration of crisis

Monitoring liquidity, solvency, and recovery plans

Resolution of troubled banks

President Banks

LPSDeposit Insurance

Agency

OJKFinancial Services

Authority

KSSKFinancial System Stability

Committee

Finance Ministry

Expanded power; e.g.,

bail-in

Advice on the state of the

financial system


terminateorwritedownthebank’sunsecuredliabilities,convertingcreditors’unsecuredclaimsintoequity(Dell’Aricciaetal.2018;FSB2014).Banksareexpectedtohaveenoughassetsandenoughflexibilityintheirdebtinstrumentstoallowthemtostabiliseinacrisis(vonAllmenandKang2018).Underthelaw,banksarerequiredtohaverecoveryplans.Theseplansshoulddetailhowthebanks’bail-inarrangementswouldoperateinacrisis,includingwhichassetstheywouldsell,whichsubsidiariestheywouldremovefromtheirholdinggroups,andhowtheywouldrestructuretheirdebtpositions(IMF2017).Unless the law is changed, theMinistry of Finance is also constrained by

Indonesia’sexistingfiscalruleforcrisismanagement,23assumingthattheextentofthebailoutsisreflectedinthebudget.Thisfiscalrulepreventsthegovernmentfromrunningbudgetdeficitsthatexceed3%ofGDP.Ifthislimitisexceeded,thepresidentcanbeimpeached(Lledóetal.2017).Thisfurtherconstrainsanalreadyrigidgovernmentbudget.Forexample,about26%ofgovernmentrevenuemustbetransferredtoregionalgovernments(Blöndal,Hawkesworth,andChoi2009).Similarly,theConstitutionmandatesthat20%ofrevenuebeallocatedtoeducation.Therearemanyexamplesoftaxrevenuesthatareprospectivelyearmarkedforparticularfunctions(e.g.,therevenuefromforestryfeesmustbededicatedtoreforestationactivities)(Blöndal,Hawkesworth,andChoi2009).ThethirdentityunderthePPKSKlawisBI.Underthelaw,BIcanonlyprovide

emergencyliquidityassistancetoatroubledbankiftwoconditionsaremet.First,thetroubledbankmustprovidecollateralofcommensuratesizebeforeBIcanassistit.Second,theOJK,thefourthentityunderthelaw,mustanalysethesituationandadviseBIthatthesystemicallyimportantbankneedsassistance(vonAllmenandKang2018).TheOJKwasestablishedin2011asanintegratedregulatorofthefinancialsector.

Itassumedoversightofthecapitalmarketsandthenon-bankfinancialinstitutionsin2012,andofthebanksin2013.24Inthiscapacity,itregulatesandsupervisesfinancialservicesinbanking,capitalmarkets,andthenon-bankfinancialsectors(OJK2019).Underthelaw,theOJKmonitorsthefinancialsectorandreportsitshealthand

developmentstotheKSSK.Aspartofthis,theOJKundertakessupervisorystressteststoidentifyweaknessesinthefinancialsystem.Italsomonitorsthebanks’recoveryplanstodeterminewhetherthebankscouldsupportthemselvesinacrisisandwhethertheyareeligibleforabail-in(vonAllmenandKang2018;IMF2017).ThefifthentityunderthelawistheLPS.Itwasestablishedin2004toinsure

depositors’fundsandtoresolvethefinancialdifficultiesofbanksandfinancialinstitutionsbyusingfundsraisedthroughabanklevy(IMF2017).Underthelaw,theLPScannotusepublicfundstoresolvethedifficultiesofabankorfinancialinstitution.Itmustrelyonitsownresourcesanditsbail-inpowersdiscussedabove.Thesepowers,however,areonlyavailableifthesixthentityunderthelaw,thepresident,declaresa‘statusoffinancialsystemcrisis’.

23.SetoutinLaw23/2003onStateFinanceLawandGovernmentRegulation.24.ThesefunctionswerepreviouslytheresponsibilityofBapepam-LKandBI,respectively(seeIMF2017).


AmajorroleoftheKSSKistoadvisethepresidentaboutwhetherafinancialcrisisisoccurringorisimminent.IftheKSSKbelieveseithertobethecase,itcanadvisethepresidenttodeclareastatusoffinancialsystemcrisis(vonAllmenandKang2018;IMF2017).Oncethisdeclarationismade,awiderrangeofresolutionpowers,suchasbail-inpowers,becomesavailabletotherelevantagenciesunderthelaw.Thebanksthemselvescomposethefinalandmostimportantentityunderthe

law.Thelawimposesseveralrequirementsonthesystemicallyimportantbanks.Theyarerequiredtodeveloprecoveryplansandtoissuedebtthatwouldcoveracontractualbail-in,allowingthemtoconvertdebtintoequityintheeventofacrisis.

Shortcomings of the PPKSK Framework: A Hypothetical Crisis Theshortcomingsof thePPKSK lawbecomeclearwhenahypotheticalcrisisisconsidered.Suppose that,asa resultofanyof therisksexploredearlier,asystemicallyimportantIndonesianbankweretosufferaliquiditycrisis.HowwouldthissituationberesolvedunderthePPKSKlaw?Ordinarily,BIwouldberesponsiblefordecidingwhetheremergencyliquidity

assistanceshouldbeprovidedtothebank.IfBIweretodecidethatassistancewouldbewarranted,itwouldprovideit,asithasduringpreviouscrises(discussedlater).UnderthePPKSKlaw,however,thedecisionrestswiththeKSSK.Theprocesswouldproceedasfollows.First,theOJKisrequiredtoprepareadviceandanalysisfortheKSSKonwhether

thebankisfacingaliquiditychallengeandwhetherliquiditysupportshouldbeprovided.Second,theKSSK(anditsfouragencies)mustagreewiththisanalysisandagreethatliquiditysupportisnecessary.Third,BImustenterintodiscussionswiththerelevantbanktoconfirmtotheKSSKthatthebankhasadequatecollateraltocoverthevalueoftheliquiditysupport.Thepracticalchallengehereisthatthevalueofthebank’sassetsmaybedecliningifthemarketisawareoftheproblemsfacingthebank,orthebankmaybesellingassetstobolsteritsliquiditybase.Itisonlyiftheserequirementsaresatisfiedthatemergencyliquidityassistancecanbeprovided.Althoughitisnotprescribedinthelaw,itislikelythattwootherstepscouldbe

takenthroughoutthisprocess.First,theKSSKmightrequestthattheIndonesianbankswithenoughcapitalandliquidity,orforeignparentbanksorshareholders,providetherequiredliquidityassistanceratherthanBI.Historically,thishasbeenunsuccessful(seenextsection)becausebanksaregenerallyreluctanttoreducetheirowncapitalbufferstoassistanotherbank,particularlyiftheyareexperiencingbalancesheetstressthemselves.Second,theKSSKmightseekpoliticalcoverbeforeanyliquiditysupportis

provided,giventhehistoricalsensitivitiesaroundsuchbailouts.Thiscouldinvolvebriefingthepresidentdirectlyonthesituationandseekinghisapprovalbeforeanydecisionismade.Thisscenarioraisestwomajorconcerns.Thefirstisthatthepotentiallysignificant

delaysinthisbureaucraticprocesscouldresultinarelativelybenignliquidityproblembecomingasystemicsolvencychallenge.Thelongerthebank’sliquidityshortfallpersists,themorealertandalarmedinvestorsmaybecome(Davis2008).As thevalueof thebankand itsassets fall, andshareholdersanddepositorswithdrawtheirstakes,thebank’sbalancesheetcouldquicklybecomeinsolvent.


Inshort,theconcernisthatthelawhaseffectivelyremovedBIasthelenderoflastresort,atleastinanyimmediatesense.UnderthePPKSKlaw,theprogressionofaliquidityproblemtoasolvency

problemwould shift the onus of responsibility fromBI and theOJK to theresolutionauthority,theLPS.It,however,hasinsufficientfundstoresolvethefinancialproblemsofasystemicallyimportantIndonesianbank(RahadianaandHo2017),andthelawpreventsitfromusingpublicfundsinitsresolutionprocess.Itsbail-inpowersarealsonotavailableunlessthepresidentdeclaresastatusoffinancialsystemcrisis.Theconcernisthat,bythetimethepresidentmakessuchadeclaration,thevalueofthebank’sassets,includingitssubsidiaries,mayhavesignificantlydeclinedinvalue,andshareholdersanddepositorsmayhavewithdrawntheirstakesfromthebank.Thiscouldmeanthatabail-inwouldbeanunrealisticpolicyresponse,giventhesizeofthechallenge.AlthoughIndonesia’sbanksarewell-capitalised,thestrengthofthatcapitalisoftennotknownuntilacrisisoccurs(HagendorffandVallascas2013).Thiscouldmeanthatabank’srecoveryplan,whichshoulddetailhowthefirmwouldrescueitselfinacrisis,maynotbeeffectiveinreality.Thesecondconcern,whichunderpinsmanyoftheaboveconcerns,isthatthe

PPKSKlawandtheKSSKcommitteeunderminetheindependence,authority,andresponsibilityofitsfourcentralagencies.Andwhileanybankbailoutinanycountryattractssignificantpoliticalattention,followingthecrisismanagementprocessoutlinedinthePPKSKlawwouldriskfurtherpoliticisingthealreadycomplexandtechnocraticprocessofcrisisresponse.Agenciesarepreventedfromrespondingtothesituationastheynormallymight.Instead,theyarerequiredtoactinaccordancewithwhathasbeenagreedbetweenthefouragenciesundertheKSSK.WhetherBIcanprovidesupportdependsonadvicefromtheOJKandtheKSSK.Thesizeofthissupportdependsontheavailabilityofcollateral.TheLPS’sactionsdependontheactionsoftheKSSKandthepresident.Supportfromthefinanceministryisruledoutandthereforedependsonchangestothelaw.Allthesecontingenciesmeanindividualagenciesareunabletoactquicklyandmaybeunabletotakeresponsibilityforsupportingorresolvingthefinancialtroubleofbanks.Addressingthislackofindividualresponsibility,however,wasamajoraimofthePPKSKlawinthefirstplace.

The Long Shadow of the Bank Century BailoutThePPKSKlawisdifficulttounderstandwithoutthecontextofthe2008BankCenturybailout.BankCentury,asitwasthenknown,wasthe13thlargestbankinIndonesia. In lateOctober2008,BankCenturybeganexperiencingseriousliquidityproblems.Thebank’smanagementrequesteda$108millionshort-termloanfromBI.BIprovidedtheassistanceandputBankCenturyunderaspecialmonitoringstatusinNovember.On20November,however,whenBankCenturywasreportedashavinganegativecapitaladequacyratio,thegovernmentdecidedthatemergencymeasureswerenecessary.Thegovernmentseizedthebankandgaveitselffiveyearstonurseitbacktohealthandthensellit.Afewdaysafterthebank’sseizure,oneofthebank’scofounders,RobertTantular,wasarrestedandlaterfoundguiltyofissuingfakelettersofcredit(Wall Street Journal2008).Thebailouthadasizeableeconomiccostofabout$700million(McLeod2010).

Butitalsohadasubstantialpoliticalcost.Thebailoutledtoriotsoutsidethe


parliamentbuilding.MembersofParliamentinstigatednumerousinvestigationsontopofthosealreadyunderway.Thetargetsoftheinvestigationsincludednumerousgovernmentofficials,suchasthethen(andcurrent)financeminister,SriMulyani,andthethenBIgovernor,Boediono.Parliamentheldavoteonwhetherthebailoutwaswarranted.Theresultwasaresoundingvoteofnoconfidenceinthegovernment(Wall Street Journal2008).AkeyconsequenceoftheBankCenturybailouthasbeennervousIndonesian

officials.Havingfacedabarrageofinvestigations,seniorofficialsinthefourKSSKagenciesreportedthattheywouldbelesslikelytoactifanotherbankorfinancialinstitutionweretorequiresupport,andthatthePPKSKlawwasdraftedforthisreason.25Thelawdeliberatelyabsolvesagenciesandofficialsfromindependentresponsibility forbankbailouts. It ensures that all agencies andofficials arerequiredtocollectivelymakedecisions.Thelawprovidesthemwithpoliticalandinstitutionalcoverifabailoutisnecessary,ratherthanrelyingonindividualagenciestoimplementspecificmandates.Theconsequenceofthisisthattheresponsetoacrisisislikelytobeslower

andlessdecisive.Liquidityshortfallscanfastbecomesolvencycrisesunderthisframework,which,dependingonthebank,canquicklybecomesystemicchallengesforIndonesia’sfinancialsystem.ThePPKSKlaw,inshort,increasesthepoliticalcoverforofficialsatthecostofincreasedsystemicriskinthefinancialsystem.

The Inadequacy of Regional and Global Safety NetsThisraisesthequestionofwhatexternalsupportwouldbeavailabletoIndonesiainacrisis.AgrowingbodyofresearchhashighlightedtheinadequaciesoftheregionalandglobalsafetynetsavailabletoAsianeconomies(Sterland2017).Theseinadequacies,combinedwithIndonesia’spoorhistorywiththesafetynets,wouldmakeforparticularlycomplexpoliticalandeconomicconsiderationsifIndonesiaweretorequireexternalassistanceinthefuture.Indonesiahasturnedtoregionalandglobalsafetynetsinthepast.26During

theAsianfinancialcrisis,IndonesiaenteredanIMFprogramthat,accordingtomanyanalysts,didmoreharmthangood(Krugman2009).WhatwasperceivedasbadadviceandunnecessaryconditionalityfromtheIMFhascreatedstigmaamongIndonesianofficialsandthepublicaboutgoingtotheIMFforassistance.WhenIndonesiafacedfinancialhardshipduringtheGFCandtheTaperTantrum,Indonesia’sauthoritiesexhaustedalmosteveryoptiontoavoidengagingthehelpoftheIMF.ThegovernmentsecuredacombinationofloansandbilateralswaplineswithAustralia,Japan,andKorea.ItobtainedaliquiditylinewiththeAsianDevelopmentBank(ADB)andhassinceexpandeditsswaplineswithothercountriesintheregion,particularlyChina.Indonesia would, it seems, have several options in a crisis. It could

access resources from the IMF, theWorld Bank, the ChiangMai InitiativeMultilateralization(CMIM),andtheADB,anditcoulddrawonitsswaplines

25.SeniorKSSKofficialsagreedtobeinterviewedforthispaperontheconditionthattheywouldremainanonymous.26.TheanalysisanddatainthissectiondrawsonTriggs’work(2018b).


withJapan($22.7billion),China($15billion),Korea($10billion),andAustralia($8billion).Indonesiaalsohasforeignexchangereservesofaround$130billion.Butonceeconomic,political,andinstitutionalconstraintsareaccountedfor,

Indonesia’soptionsaremorelimited.IndonesiawouldbeunlikelytoseekfundingfromtheIMF,becauseofthecountry’sbadhistorywiththeorganisation,andtheWorldBankrarelyprovidesliquiditysupportoutsideofanIMFprogram.TheCMIMisuntestedandconsideredbymanytobeunreliable(Sterland2017),andliquiditysupportfromtheADBcannotbeguaranteed.ThisleavesIndonesiatorelyonapatchworkofloansandbilateralswaplineswithcountriesintheregion.Buteventhesemaynotbeavailableinacrisis.TheReserveBankofAustralia,forexample,hascautionedcountriesthatswaplineswithAustraliaareavailableonlywhenthereisashortfallinforeignexchange(e.g.,fortradefinance)andwouldnotbemadeavailableifacountrywerefacingbalance-of-paymentsdifficulties.Othercentralbankshavemadesimilarstatements.

Other Shortfalls in Indonesia’s Regulatory FrameworkThere are several other challenges facing Indonesia’s regulatory framework,discussedindetailbyvonAllmenandKang(2018).TheOJKfacesaparticularchallengeinregulatingfinancialconglomerates.MostfinancialconglomeratesinIndonesiahaveahorizontalstructurethatincludesbanks,insurers,andothersubsidiariesthataresubjecttoregulation.Theholdingcompanythatcontrolsthegroup,however, isoftenunregulated.The lackofaregulatedbodywithclearascendancyoveralltheentitiesthatformaconglomerateposesimportantchallengesfortheconsolidatedsupervisionoftheconglomerate.TheOJKhasbeentryingtoaddressthisproblembynominatingafinancialinstitution,usuallyabank,astheleadentityofconglomerates.However,thiskindofleadentitylacksthelegalauthoritytoimposetheOJK’sregulatoryrequirementsonthegroup,andcompanylawrequirementsmayhinderinformationflows(vonAllmenandKang2018).BIisplayinganincreasinglyimportantroleinmacroprudentialpolicy,whichis

importantforbolsteringfinancialstabilityandpreventingtheformationofassetpricebubbles(Warjiyo2017).ButBI’smandateisnotclearlydefinedinlegislation(IMF2017).AmendingtheBIlaw(Law23/1999onBankIndonesia;amendedwithLaw3/2004onBankIndonesia)sothatitincludesamacroprudentialmandatefocusingonsystemicriskandcoveringtheentirefinancialsystem,notjustthebanks,couldclarifyBI’srole.ProvisionscouldalsobemadetograntBIaccesstothenon-bankfinancialdataneededforsystemicriskmonitoring.

Reforms to Strengthen the PPKSK LawThe PPKSK law could arguably be reformed to strengthen and clarify theindependentrolesandmandatesofagencies,andothersunderthelaw.SeniorofficialsinthefourmainregulatorsoftheKSSKsuggestthatithasbeena

usefulbody.Ithasimprovedcoordination,collaboration,andinformationsharingbetweenagencies,anditwouldlikelyplayavitalroleinensuringacoordinatedresponsetoacrisis.ButthereisastrongargumentthatthisiswheretheKSSK’sroleshouldend.TheKSSKshouldnothavethepowertodirectmemberagenciesintheirrespectiveareasofresponsibility.Itsroleshouldbelimitedtocoordination,andinformationanddatasharingbetweenagencies.


ThereisalsoastrongargumentforreinstatingBIasIndonesia’slenderoflastresort.ThiswouldentrustBIwithdecidingwhetherabankorfinancialinstitutionneededliquiditysupportandwouldmakeitresponsibleforprovidingthatsupport.TheKSSKandotherregulators,notablytheOJK,havearoletoplayininformingBI’sdecision.Butthedecision,andtheprovisionofsupport,wouldultimatelybeamatterforBI.BankIndonesia’smandateonmacroprudentialmeasuresshouldbeclarifiedinlawtopreventitsdecisionsandpoliciesbeingchallengedinthefuture.Law21/2011ontheFinancialServicesAuthorityshouldgiveunambiguous

primacy to theOJK’smandate tomaintainfinancial stability (consistentwiththePPKSKlaw).TheOJK’sabilitytoregulatefinancialconglomeratesshouldbestrengthened.ThelawshouldbeamendedsothattheOJKcanrequiretheestablishmentof,andlicenseandsupervise,anon-operatingfinancialholdingcompanyoffinancialinstitutions(seeIMF2017).TheLPSwillplayavitalroleifaliquiditycrunchbecomesasolvencycrisis.

Thereisanargumentformakingitsbail-inpowersavailableregardlessofwhetherthepresidentdeclaresafinancialcrisisornot.TheLPSdepositinsurancelimitof$150,000isprobablytoohigh,giventhatmostdepositsinIndonesianbanksarefarsmaller.TheIMFhaswarnedthatsuchahighlimitcouldresultinincreasedmoralhazard,weakermarketdisciplineinbanks,fundingshortfallsrelativetotheLPS’sobligations,andareducedscopeforbail-ins.Theroleofthepresidentshouldbelimitedtodecidingwhetherpublicfunds

shouldbeusedtobailoutaninstitutionratherthandecidingwhenagenciescanusetheirpowers.Minimisingtheextenttowhichtaxpayersarerequiredtobailoutbanksandfinancialinstitutionsisalogicalobjective.Butallowingpublicfundingtobeusedinthecaseofacrisisgivesthegovernmentmoreflexibility,whichmaybevitalinanemergency.Toensureaccountability,publicfundsshouldonlybeusedifapprovalhasbeenobtainedfromthepresident.Indonesia’sfiscalrulealsoconstrainsthegovernment’sflexibility.Butithasbeenimportantinprovidingpoliticalcoverforpoliticianswhoattempttoaddressbudgetinefficienciesorrejectproposalsforunsustainableincreasesinspending.Theseproposedreforms,however,ignoreavitalreasonthatthePPKSKlaw

wascreated.Thelawcamefromaconcernaboutalackoflegalprotectionamongpolicymakers.Thelawshouldbestrengthenedtolegallyprotecttheofficialsinrelevantagencies.ThetestforlegalprotectionunderthePPKSKlawisfora‘misuseofauthority’ratherthan‘goodfaith’.Furthermore,thelegalprotectionunderthelawappliesonlytoactionstakeninsituationsofnear-crisisorcrisis.Itdoesnotextendtotheinstitutionitselfandthepersonsactingonitsbehalf(seeIMF2017).Strengtheningtheselegalprotectionswouldhelpensurethatofficialsactquicklyanddowhatisnecessaryinacrisis.

REFORMS: GROWTH AND STABILITY THROUGH FINANCIAL DEEPENING AND FINANCIAL INCLUSIONWhiletheIndonesianeconomyisapproaching20yearsofuninterruptedgrowth,Indonesia’sfinancial system remains shallow.Financialdeepening isvital toboostlong-termfinancialstability(Apergis,Filippidis,andEconomidou2007).Itisalsovitalforeconomicgrowth.AstudybyEkbergetal.(2015)estimatesthatforIndonesiatoachieveitsGDPgrowthaspirationsof$4.1trillionby2030,itsfinancial


capitalbase(thesumofitscorporatebondsandequitymarkets)willneedtogrowby6–8timesthesizeitwasin2014.TotalassetsinIndonesia’sfinancialsectorequalabout70%ofGDP,compared

withabout400%inKorea,300%inChinaandSouthAfrica,and200%inIndia(IMF2017).Indonesia’sstockmarketcapitalisation-to-GDPratioremainsoneofthelowestintheAsiaPacific,despitetheratioalmostdoublingfrom27%in2000to47%in2017(figure6).Indonesia’sdeposits-to-GDPratiohasremainedconsistentlybelowitspeers’ratios,averaging34%from1999to2016(figure7).Indonesia’sfinancialsectorisdominatedbybanksandcanbesplitintothree

subsectors:thebankingindustry,thecapitalmarket,andthenon-bankfinancialinstitutions(NBFIs).In2018,Indonesia’sbankingsectoraccountedfor76%ofthetotalassetsinthefinancialsector(OJK2018).Bankassetsequalled55%ofGDP,andbankloansaccountedformorethanhalfofdomesticfinancing(Rp357trillion)in2017.Incontrast, theassetsof insurancecompanies, thesecond-largestcategory,

equalledonly7%ofGDP.Foreigninvestorshold38%ofIndonesiangovernmentsecurities,higherthantheaverageof26%forAsia’semergingmarketeconomies.Thecombinationofashallowfinancialmarketandhighforeignparticipationcaninducevolatilityintimesofstress.NBFIsaregrowingfast.Inthetenyearsto2015,thetotalassetsoffinancial

institutionsgrewbyabouteightpercentagepointsofGDP.MorethanhalfofthisincreasecamefromNBFIs,particularlyinsurancecompanies(mainlylifeinsurancecompanies).Butwhilethisgrowthhasbeensignificant,itcomesfromalowbase(IMF2017).Indonesia’sauthoritieshavesetoutplansforfinancialdeepening.TheOJK

announcedaFinancialServicesSectorMasterPlan(2015–19)inJanuary2016.Theplanseekstooptimisetheroleofthefinancialsectorinacceleratingeconomicgrowth;tomaintainfinancialsystemstability;toenhancethepublic’sfinancialindependence; and to support equitable economic development (OJK 2016).Thegovernmenthasalsointroducedacoordinatedfinancialinclusionstrategyto expand access to banking services. This National Strategy for FinancialInclusion (SNKI) focuses on financial education, public financing facilities,financialinformationmapping,supportiveregulations,distributionnetworks,intermediationfacilities,andconsumerprotection.Thestrategyisexpectedtoincreasetheshareofhouseholdsthathavebankaccounts,from36%in2016to75%by2019.Thedevelopmentofdigitalfinancialserviceswillbeacentralpartofthisstrategy(Parlina2018).Asambitiousasthesepolicyframeworksare,itistooearlytospeculateabout

theireffects.MuchneedstobedonetodeepenIndonesia’sfinancialmarketandpromotefinancial inclusion. Inthepast20yearsorso, theneedforfinancialdeepeninghasbeendiscussedinmanypublicationsandreports,resultinginnumerousrecommendations.27Thefollowingthreeneedsforreformstandoutin

27.TheIMF,theWorldBank,andtheADBregularlypublishresearchonIndonesia’seconomicdevelopmentanditsfinancialmarket.IndependentresearchinstitutionssuchastheMandiriInstitutealsocontributeanalysis.The Bulletin of Indonesia Economic StudieshasbeencloselyfollowingIndonesia’seconomyandfinancialreformsformanyyears.


FIGURE 6 Stock Market Capitalisation as a Percentage of GDP (%)

Source: World Bank (2019).

2000 2005 2010 20150

20

40

60

80

100

120

140

160

Thailand IndiaIndonesia Philippines Malaysia

FIGURE 7 Financial System Deposits as a Percentage of GDP (%)

Source: World Bank (2019).

1999 2004 2009 20140

20

40

60

80

100

120

140

Thailand IndiaIndonesia Philippines Malaysia


thisliterature:theneedtoeasethecreditconditionsofbanks;theneedtoenlargethesizeandshareofNBFIsandthecapitalmarket(increasingthesizeofthepie);andtheneedtodevelopmorefinancialinstruments.

Easing Banking Credit ConditionsThetighteningofcreditconditionsfromApril2018toJanuary2019reflectstheshallowandbank-dominatedstructureofthefinancialsystem.Itisalsoaresultofthebanks’largecapitalbuffersandthecompetitionfordepositsthatcomesfromthegovernmentbondmarket.Asprimaryfinancingchannels,thebanks,especiallythelargebanks,aremainlyresponsibleformeetingthelargefinancialneedsofinvestorsandthegovernment,particularlyforitsinfrastructureprogram.Asdiscussedearlier,thecapital-to-assetsratioofIndonesia’sbanksishigherthanrequiredunderBaselIII.Thispartlyreflectstheneedofthebankstoself-insure,duetothepolicyofbailingin,notbailingout,firmsincrisis.Marketparticipantssuggestthatthishasledthebankstoraiseadditionalcapital,whichhascontributedtotightercreditconditions(Ekbergetal.2015).Thebanksalsofacecompetitioninattractingdeposits.Therateofreturnongovernmentbonds(someintheformofcorporatebondsissuedbySOEs)reached7.8%inJune2018.Thisismoreattractivethanthebankdepositrateofaround5.5%.Thiscrowding-outeffectisparticularlyprominentfortheBUKU3and4banks,whichhavefacedtightercreditconditions.The government and regulatory bodies should focus on addressing these

distortionsinordertoeasecreditconditionsforthebanksandtohelpdeepenthe financial system while preventing further vulnerability and instability.Policymakersshouldbeawareofthetighteningofthefinancingenvironmentwithinbanks,andtheyshouldseektodivertsome,ifnotall,ofthefinancingneedstoNBFIsandthecapitalmarket.Thiswouldnotonlyreleasethecredittensionofthebanksbutalsohelpthenon-bankingfinancialintermediariesandcapitalmarkettogrow.

Developing the Capital Market and Non-banking Financial IndustryThetotalassetsoftheNBFIsandthecapitalmarketcombinedaccountforathirdofIndonesia’sfinancialassets.Thissmallsharehascontributedtotheshallownessofthefinancialsystem.Toensurefinancialdeepeningandinclusion,effortsshouldbemadetoexpandthefinancialmarket.Specifically,policiesshouldfocusonfurtherdevelopingtheNBFIs,suchaspensionfunds,insurancecompanies,andmutualfunds.Theyshouldalsofocusondevelopingthecapitalmarket,includingbydevelopingthemoneymarket.Reformsareneededtoenlargethedomesticinstitutionalinvestorbase,especially

by encouraging long-term institutional investors in the market. DomesticinstitutionalinvestorsinIndonesiacurrentlyhaveashort-termfocus.Forexample,definedbenefitpensionfundsfocusonshort-terminvestmentreturnsratherthanlonger-termopportunities(Ekbergetal.2015).Regulatorsandpolicymakersshouldencourageinvestorstorevisetheirevaluationcriteria,discouragepeoplefromwithdrawingtheirpensionsavingsbetweenjobs,andprovidesubsidiesandmoreincentivesforlong-terminvestmentproducts.Effortsshouldbemadetoencouragetheestablishmentofpensionfunds,money

marketfunds,andmutualfunds.MoneymarketsinIndonesialackaclearingmechanism.Themoneymarketisasymmetric,withafewlargebankslendingand


othersborrowing.Aclearingmechanismwouldhelptomitigatecounterpartyriskandmakeiteasierforsmallerbankstoaccessinter-bankfinancing(smallerbanksareperceivedasriskierthanlargerbanks).Additionally,policiestofurtherdeveloptheinsurancesectorwithlesslinkage

tobankswillbevital.Theinsurancesectorhasbeengrowingatanaveragerateof20%peryearoverthepastfewyears.28Abouthalfoftheinsurersbelongtoconglomerates,whicharelargelyledbybanks.Theconnectionsbetweeninsurersandbanksmayexposeinsurerstoexternalrisks,whichcouldmateriallyaffectthebanksaswell.Todeveloptheinsurancesectorwithoutinducingundesirablerisks,reformsshouldfocusoninsurerswithlittleconnectiontobanks.29

Expanding Access to Finance and Financial Instruments Technologicalinnovationsthroughfinancialtechnology(fintech)havebecomeimportantinstrumentsforpromotingfinancialinclusioninIndonesia.Fintechenableshouseholdsinremoteareasandsmallbusinessestoaccessbankloansand/orpeer-to-peerloans.FintechinIndonesiahasbeendevelopedprimarilybythebankingsectorandallowshouseholdsinremoteandruralareasandsmallbusinessestoaccessbankcreditandpossiblyotherfinancingchannelsovertime.ComparedwithcountriessuchasIndiaandChina,Indonesiastillhassignificant

potentialtodevelopfintech.Policiesshouldbeimplementedtoboostthegrowthoffintechinstrumentsinthefuture.Furthermore,tofacilitatethedevelopmentofthemoneymarket,severalinstrumentsshouldbeintroduced,includingfloatingratenotes, certificatesofdeposit, and commercialpaper.Thiswouldhelp toremovetheincentiveforfirmsandhouseholdstoshiftmoneyoffshore,wheremoreinstrumentsareavailabletomeettheirfinancialneeds.AttractingthesefundsbackintoIndonesiawillbevitalintheoveralldeepeningofthefinancialsystemandstrengtheningoffinancialinclusion.

CONCLUSION AND FINDINGSTheglobaleconomyhasproducedacomplexenvironmentforIndonesia.Testingthe resilience of the Indonesian economy are rising global interest rates, anappreciatingUSdollar,tighteningglobalfinancialconditions,growthdowngrades,theriseofthefar-right,geopoliticaltensions,theunderminingofglobalinstitutions,theUnitedStates–Chinatradewar,andthethreatofaUSrecessionandpolicyuncertaintyfromBrexit.Indonesiahasmanagedthesechallengeswell.Itscapitaloutflowsweremuch

smallerthanintheTaperTantrum,andtherupiahhadregainedmostofitslostgroundbyJanuary2019.Indonesia’sstockmarkethasoutperformeditspeers,growth is forecast to remain stable, inflation is low,unemployment remainsbelowitsfive-yearaverage,consumerandbusinessconfidencearerobust,and

28.In2015,insurancecompanyassetscomposedonlyabout7%ofGDP,comparedwith15%inpeercountriesintheAsiaPacific(IMF2017).29. Law 40/2014 on Insurance appears to have improved insurance regulation andsupervision.SeeIMF(2017)foranassessmentoftheinsurancecoreprinciplesspecifiedbythislaw.


thegovernment’sbudgethasimprovedthroughasmallerdeficitandcheaperborrowingcosts.Butbeyondtheseshort-termindicators,significantrisksremainfortheeconomy.TheincreaseddebtofIndonesia’sSOEs,thethreatofliquiditywithdrawalfromIndonesia’sbankingsystem,theexpansionofgovernmentdebtheldbyforeigners,andthegrowingrelianceonshort-termborrowingbynon-financialcorporationscouldtesttheresilienceofthefinancialsystem.Giventhelikelyinadequacyofglobalandregionalsafetynetsinprovidingthenecessarysupport, the effectiveness of Indonesia’s crisismanagement framework—thePPKSKlaw—willbecrucial.Thispaperhasshown,however,thatthelawhasseriousdeficiencies.Itmay

dilutetheaccountabilityandresponsibilityofindividualagencieswithintheKSSK.Thiscouldleadtoaslowresponsetocrises.Itcouldseekeyregulatorsfailingtoactquickly,orfailingtoactatall,anditeffectivelyremovesBIfromactingasIndonesia’slenderoflastresort.Theframeworkalsocomplicatesthepoliticsofaprocessthatisalreadytoocomplex.Combined,theframeworkcouldresultinliquidityshocksbecomingfull-blownsolvencycrises,requiringinterventionbythepresidentandParliamentforagenciestousetheirpowerstoaddressthecrisis.ApriorityofthegovernmentshouldbetostrengthenthePPKSKlaw.Public

officials should have better legal protection when they act in good faith inresponding to financial and economic crises. Individual agencies should bechargedwithresponsibilitiesintheirrespectiveareasofexpertise,withtheKSSKplayingonlyaninformation-sharingrole.BIshouldbereinstatedasIndonesia’slenderoflastresort.TheOJK’sabilitytoregulatefinancialconglomeratesshouldbestrengthenedandtheLPSshouldbeabletoaccessitsbail-inpowerswithoutpresidentialapproval.Thepresident’sroleshouldbelimitedtodecidingwhetherpublicfundingcanbeusedinabailout.Inthelongerterm,thegovernmentshouldredoubleitsreformeffortstodeepen

itsfinancialsystem.Thisisvitalforbothfinancialstabilityandeconomicgrowth.WhileIndonesia’seconomyisapproaching20yearsofuninterruptedgrowth,itsfinancialsystemremainsshallowrelativetoitspeers.Threeareasofreformdeservespecialattention:theneedtoaddressthedistortionsthatconstrainthefinancingconditionsofbanks;theneedtogrowthesizeandshareofNBFIsandthecapitalmarket(includingpensionfunds,insurancecompanies,andmutualfunds);andtheneedtodevelopmorefinancialinstruments,includingbyexpandingaccesstofintechforhouseholdsandsmallbusinesses.Insum,strengtheningfinancialresilienceinIndonesiarequiresshort-andlong-

termreforms.Thespillover-richinternationalenvironmentofrecentyears,inwhichfinancialandpolicydevelopmentsinonecountryhavehadsignificantimplicationsforothercountries,showsnosignsofabating.TheresilienceofIndonesia’sfinancialsystemcouldbetestedsoonerratherthanlater.


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