Vietnam's economy soars as capital inflow surges

Thursday, May 03, 2007, The Jakarta Post

The Vietnam News Agency and Asia News Network organized an international conference on regionalism and modernization of Vietnam in Ho Chi Minh City on April 23 and 24. Vincent Lingga represented The Jakarta Post, a member of ANN, at the meeting. The following are his reports.

Almost 20 years after abandoning its collectivist economic strategy to implement market-based reforms, Vietnam has become one of the best-performing developing economies in the world with an annual growth of 7 to 8 percent over the past eight years.

Although not a complete picture of success - as it is still a poor country with a per capita income of US$700 - Vietnam has, to some extent, achieved economic development.
Vietnam's economy is on a roll and the outlook is quite promising.

It is amazing to see how a country ravaged by war for decades has been able to catch up so fast. Vietnam has now become one of Asia's most open economies, with two-way trade totaling US$85 billion last year and accounting for more than 60 percent of its economy.

Vietnam is now the world's biggest pepper exporter, second largest rice exporter after Thailand and a leading exporter of coffee, tea and shrimp.

Remarkably, Vietnam's high economic growth has not impacted on income inequality. The poverty rate has decreased from 60 percent in 1990 to around 15 percent. More than 90 percent of rural households now have electricity.

Where did Vietnam go right and where does Indonesia lag?

Foreign analysts, investors, businesspeople and Vietnam's senior officials, who declared Vietnam an economic success story at an international seminar last week, gave credit to consistent reform, strong government leadership and industrious citizens with great entrepreneurial spirit as the key factors.

Strong leadership succeeded in reducing animosity toward the United States, an enemy until the war ended in 1975; the French, the country's former colonialists; and China.

"This is by no means a small achievement, because almost every family has had a relative killed in the war. However, we decided to bury hatred in the past and turn our attention and energy to providing employment and creating prosperity," said Dao Duy Chu, senior economist and former chief executive officer of state-owned PetroVietnam.

Vietnam watches China carefully to learn from its neighbor's mistakes. Duy focussed particularly on income inequality between people in rural and urban areas.

Vietnam has not been suspicious of the Washington-based World Bank and International Monetary Fund, even though many other developing countries consider these an extension of U.S. foreign policy. Vietnam rejoined both institutions in 1993 and has since benefited greatly from intensive policy discussions with seasoned economists and technical assistants.

Even though Vietnam has never been heavily dependent on foreign aid (it accounts for less than 15 percent of public-sector spending), 30 donors are now actively engaged in extensive policy reform under the coordination of the World Bank.

Like many other developing countries, reform in Vietnam initially occurred in a haphazard manner, but as success eventually bred success, confidence rose and encouraged even bolder reforms.

An egalitarian redistribution of farmland early on, coupled with free trade in agricultural products and better agricultural support services at the local level, led to a boom in exports and a dramatic reduction in rural poverty.

"I think reform (doi moi) in Vietnam was successful because it started in the agricultural sector and created a basis for a stronger national market," said Pietro P. Masina, a senior economist from the University of Naples, who has long studied Vietnam's development strategies.

The egalitarian redistribution of land to rural households allowed for a strong recovery of the agriculture sector, which became a safety net for many people when the economic crisis hit East Asia in 1997, Masina said.

Foreign investment grew as domestic entrepreneurial spirit was unleashed. Urban residents moved into paid employment, further reducing the number of rural poor and spurting economic expansion.

Vietnam permitted 7,067 foreign direct-investment projects worth US$63.55 billion between 1988 and March, 2007, according to the ministry of planning and investment.

"In the last five years our National Assembly enacted 84 laws, 60 of which are related to rules of the game in a market-based economy," said Vu Khoan, representing the prime minister.

Included among the new laws are the unified Investment Law, which provides equal status to both domestic and foreign investors, and legislation regarding the securities market, real estate market, credit organizations, science and technology transfer from foreign to domestic companies.

Vietnam avoided the economic crisis of 1997-1998 that devastated other Asian economies, including Indonesia. Vietnam's economic growth rate has exceeded 8 percent in the last two years and the government has increased reforms, now aiming for middle-income country status by 2010.

Vietnam's communist regime has another track record to be proud of. While Indonesia's reform of its state enterprises has been bogged down in narrow-minded nationalist sentiments and vested-interest capitalists, Vietnam has recorded impressive progress in the reform and privatization of state companies.

Figures presented at the seminar showed that state companies have performed reasonably well over the past few years, with more than 75 percent profiting with rates of return on equity (ROA) of 7-8 percent a year. ROA of most state companies in Indonesia, a market economy, was only between 2 and 4 percent over the same period.

Massive privatization halved the number of state firms to around 3,000 over the past five years.

"We will privatize 600 more state companies this year, including those operating in power, post, telecommunications, aviation, maritime, oil and gas, finance, insurance and banking," said Deputy Minister of Planning and Investment Nguyen Bich Dat.

Privatization has created space for the expansion of private firms. As the private sector expands rapidly, both domestic and foreign-invested firms have connected well with global markets.
Private firms now contribute 65 percent of manufactured products and over 70 percent of non-oil exports. Vietnam is progressively becoming an integral link in international production and distribution chains.

Vietnam's geographical location is also a great advantage. Vietnam is strategically located in the Greater Mekong Sub-region (GMS), comprising Cambodia, Laos, Myanmar, Thailand and two provinces of southern China. Vietnam will play a major role as a regional economic hub.

The tremendous growth of tens of thousands of family firms, resulting from a bold government move in 2001 to ease restrictions on small businesses, is quite impressive.

Vietnam's accession to the World Trade Organization (WTO) in January has exposed its agriculture sector and companies to new competition and will accelerate the modernization of the legal system.

Vietnam should be proud of the high-quality, egalitarian growth that has been the key to maintaining social cohesion.

The biggest challenge facing the ruling communists is how to continue delivering jobs, public services and prosperity.

Official statistics show that one million young Vietnamese join the labor force each year and another one million rural people migrate to the cities annually.

"Social cohesion will continue as long as the economy expands steadily with an equitable distribution of income," noted Nguyen Van Tan, chief executive officer of T&T, a service and consulting company.

Moreover, Tan added, the Communist Party will continue to gain respect from the people because it has ruled the Vietnam since 1930 and successfully led its citizens through a succession of wars against foreign colonialists.

But as Vietnam's economy becomes more sophisticated, new challenges emerge and the need arises for better feedback mechanisms from its citizens on the quality of public policy and higher standards of transparency and accountability.

Like China and India, Vietnam has benefited enormously from the return of citizens who had fled the country. Thousands of Vietnamese have returned from overseas after learning English, gaining entrepreneurial experience and acquiring technical skills.

However, as the Vietnamese enjoy more economic freedom and as more of their countrymen and women return, bringing foreign ideas of pluralism and free speech, expectations of political liberty and free expression of opinion will grow.

The Vietnamese government appears to realize the challenges and consequences of this economic development.

"Many issues, such as the inadequate and inconsistent legal system, complex administrative procedures, overlapping departments and ambiguous responsibilities of state institutions and incompetent and corrupt civil servants have yet to be resolved," Khoan said.

A businessman from Europe expressed great concern, particularly over high-level corruption related to big government projects or business deals with state companies but "they are taking serious steps to tackle this problem."

The businessman, who insisted on anonymity, welcomed a government decision to gradually open a mechanism for expressing grievances.

"The government has previously allowed street protest demonstrations, though only a very small number of people joined," he said.

Wooing investors through industrial parks

Thursday, May 03, 2007, The Jakarta Post

The Vietnamese government has, since the launch of its market-based reform in 1986, tried to woo foreign investment mostly through industrial parks, which in Indonesia are known as industrial estates.

The biggest advantage of such an approach is that industrial zones can be well planned and designed according to the spatial plan of each of the 64 provinces and cities across Vietnam.

But what makes these facilities exceptionally attractive to investors, especially those from overseas, is that a developed industrial park already has all the basic infrastructure in place.

Most helpful is that the licensing authority is centralized in the management board of each

industrial park, thereby making it virtually a one-stop licensing center for an investment venture, except for investment projects in "sensitive sectors" that have to obtain approval from the prime minister.

No wonder many foreign investors, including those from Singapore, Thailand and Taiwan, have been putting money into industrial park development.

It's different to Indonesia, where numerous infrastructure development projects are held up by land acquisition problems. The construction of industrial parks in Vietnam, with sizes ranging from 300 to 1,000 hectares, runs smoothly it is the local administration that is responsible for land acquisition.

Investment projects in industrial parks also are entitled to various forms of tax incentives and import duty relief for capital goods and materials, depending on the categories of industries in which they operate.

With lower minimum wages (US$45-55 a month) but higher productivity and a more expedient business licensing system than Indonesia, Vietnam ranked 98th out of 175 countries surveyed by the World Bank last year in terms of ease of doing business. Indonesia ranked 135th.

There are now more than 135 industrial parks in various stages of development across Vietnam, of which 15 are located around Ho Chi Minh City alone. No wonder this vibrant city accounts for almost 30 percent of FDI flows to Vietnam.

Take for example, the Vietnam-Singapore Industrial Park (VSIP) in Binh Duong province near Ho Chi Minh City, a joint venture between a consortium of five companies from Singapore led by SembCorp Industries and state-owned Becamex IDC Corp.

Less than ten years after its launch in 1996, the 500-hectare industrial park has been completely sold or rented to industrial investors, so that VSIP 2e with 345 ha is being developed to meet the increasing demand from new investors.

"About 300 foreign investors from 22 countries have or are establishing plants in our industrial parks with a total investment of $1.5 billion, generating more than 40,000 jobs," said Huynh Quang Hai, VSIP vice president.

Likewise, the Amata Group from Thailand has been developing a 700-ha industrial park in Bien Hoa in a joint venture with state-owned Sonadezi Bien Hoa. More than 90 investors have leased industrial plots in the park.

"We were attracted to this country 16 years ago by the policy consistency and decisive leadership of the government," noted Vikrom Kromadit, chairman of the Amata Group.

The CT & D Group from Taiwan entered Vietnam even earlier, in 1990, opening the first industrial park in Vietnam, which also serves as an export processing zone. It now hosts hundreds of industrial factories with a total investment of some $1 billion, creating more than 60,000 jobs.

"You should choose the market with the highest growth potential and the most understanding government to invest in," said Arthur King, chairman of the CT & D Group in reply to a question asking why his company had invested almost $1 billion in Vietnam in industrial parks, power plants and urban development centers.

King added he did encounter problems in Vietnam as investors did in most other developing countries. "But in my own experience, every time a difficulty arises, I have always found a helping hand here to guide us through the process."

-- JP/Vincent Lingga

Telecom industry needs more foreign players

Thursday, April 5, 2007 Vincent Lingga, The Jakarta Post, Jakarta 

Five years after the conclusion of what was then dubbed a strategic deal that would help restore foreign investor confidence in Indonesia, the almost 42 percent Singapore shareholding in PT Indosat is still being whipped up by narrow-minded nationalists as a subterfuge to advance the vested interests of several businesspeople.

The issue of foreign ownership in Indonesian companies such as PT Indosat, PT Telkomsel and PT Excelcomindo surfaced again at a seminar on the future of the Indonesian telecommunications industry at the Centre for Strategic and International Studies (CSIS) here last week.

Last year, several trade unions at state companies issued a demand urging the government to buy back Indosat shares from Singapore Technologies Telemedia Pte (STT), expressing fears that Singapore interests would control the country's telecommunications industry, notably its mobile phone business.

There had reportedly been a tacit agreement between the government and the House of Representatives that the government would buy back STT's shares in Indosat.

However, several analysts suspected it was in the vested interests of several national businesspeople who had been eyeing the STT stake in Indosat.

Some misguided politicians at the House have naively trumpeted the fear that Singapore's presence at Indosat could threaten Indonesia's security as the island republic could easily access various data banks and the information system in the country.

Whipping up such an inordinate fear shows either a total misunderstanding about the telecommunications industry or is simply a blatant subterfuge to mislead the general public into an emotional opposition to foreign ownership of telecommunications companies.

Questioning the business and economic rationale of the STT-Indosat deal that was concluded in late 2002 is nothing but simply an attempt to whip up narrow-minded nationalist sentiments at the expense of our telecommunications industry.

Just a flashback to the STT-Indosat share transaction in 2002:

When the then cash-strapped government offered the then debt-ridden, state-owned Indosat to buyers through an international competitive bid, the mobile phone business of Indosat subsidiary PT Satelindo had been steadily losing its market share to PT Telkomsel, a subsidiary of state-owned PT Telkom.

Indosat's former core business as the mandated monopoly provider of international call services had increasingly been taken away by other much cheaper alternative communications means such as chatting facilities and Voice Over Internet Protocol. Worse still, the market share of Indosat's satellite service had been eroded by other satellites orbiting in Asia's outer space.

On the other hand, STT has been advancing as a global communications service provider, which offers a wide variety of services including fixed and mobile telephony, e-commerce solutions and services, paging, mobile-data communications, digital mobile communications network, satellite services.

It was then crystal clear that business and macroeconomic wise, STT's entry to Indosat as a major shareholder would ensure Indosat's survival in the highly-competitive and capital and technology-intensive telecommunications industry.

Put another way, STT brought a strong synergy to Indosat.

Indosat has since 2002 had a wide access to STT expertise and modern technology that is quite vital for the further development and competitiveness of Indonesia's telecommunications services. All this can now be seen in the dramatic growth Indosat has made over the past four years.

Yet most important, STT's presence at Indosat not only jump-started the modernization of Indonesia's telecommunications industry but also injected keener market competition to state-controlled PT Telkom, the country's largest telecommunications company.

True, the Singapore government-owned Temasek controls both STT and SingTel, which owns 35 percent of PT Telkomsel, the cellular phone subsidiary of Telkom. Indosat in turn controls PT Satelindo, the second largest mobile phone company after Telkomsel.

But it is inordinately irrational to allege that the STT-Indosat alliance would lead to a monopoly of the cellular phone business. There are too many players and too many choices of technology in this business to allow for a monopoly now.

There is enough room for many players because the cellular phone market, though the fastest growing segment of the industry, is still very young in Indonesia.
An efficient telecommunications industry is key to economic development and a vital infrastructure, especially in a vast archipelago country as Indonesia.

Instead of buying back shares from foreign investors -- which means capital flight -- the government should invest in other basic infrastructures, which are less attractive to private investors such as water, ports, airports and roads.

Certainly, there is not any ban on Indonesian private investors buying Indosat shares or other telecommunications companies. They are free to buy the stocks, but at market prices. Both Indosat and Telkom are listed in Jakarta, New York and London.

But the blunt fact is Indonesia's telecommunications industry is still much less developed than those in other Southeast Asian countries. We therefore need easy access to foreign expertise, capital and technology to make the industry competitive and to expand telecommunications networks throughout the country.

Centralizing investment licensing a bad idea

Monday, April 02, 2007 Vincent Lingga, The Jakarta Post, Jakarta

Then president Megawati Soekarnoputri tried to centralize the licensing of foreign and domestic investment in the Investment Coordinating Board (BKPM) in 2004, but failed because of the strong bureaucratic jealousy between government institutions.

Going off in a strikingly different direction, President Susilo Bambang Yudhoyono announced plans in May 2005 to dilute the function of the BKPM into simply a promotion and company registry office, and to decentralize investment licensing in the spirit of local autonomy.

But except for putting the BKPM under the jurisdiction of the Trade Ministry, no other concrete measures have been taken to follow up on that idea.

The new investment law that was enacted by the House of Representatives on Thursday seeks not only to upgrade and strengthen the status of the BKPM, but also to centralize investment licensing at this agency under the concept of a one-stop investment licensing and service center.

However, the articles in the new law regarding the delegation to the BKPM of licensing authority by the various ministries and regional administrations are so ambiguous that past mistakes could be repeated, with investors again finding themselves stuck in a bureaucratic maze.

The law stipulates that the investment board shall be led by an official with ministerial status who is responsible directly to the president. This is, to a certain extent, similar to the BKPM's status under Soeharto's authoritarian administration. During the New Order, the investment board was considered a non-ministerial government institution under the oversight of the President's Operation Offices (State Secretariat).

However, the law also states in another article that the BKPM, in executing its function as a one-stop licensing and service center, shall involve direct representatives from related ministries and regional administrations.

This means that all ministries, government agencies and regional administrations related to the licenses/permits and services/facilities needed by investors should assign representatives to the BKPM.

Hence, the investment board will have officials from Manpower and Transmigration Ministry for processing work permits for expatriates, from the Justice and Human Rights Ministry for residency permits and entry visas, the Finance Ministry for granting tax and import duty incentives, etc., etc.

This could be the trap that makes the concept of the one-stop licensing and service center unworkable, because the law does not explicitly require the various ministries and regional administrations to transfer their licensing authority fully to the BKPM.

The new provisions will only spare investors the arduous procedures that require them to go from one ministry to another, from one regional administration to another, to obtain the various permits or facilities needed for their investment projects. Investors need only to file their applications with the BKPM, which is responsible, on behalf of the investors, for obtaining the necessary permits or facilities from the relevant ministries.

But inter-ministerial coordination has always been the weakest point of the government. Even the authoritarian, centralized administration of Soeharto took almost 15 years to make the BKPM a one-stop administrative center for investors. But this facility broke down soon after Soeharto's fall.

The reason behind the extreme difficulties in inter-ministerial coordination is not only the pervasive bureaucratic jealousy. From the perspective of public administration, seen as one of the most corrupt in the world, licensing authority means money for officials.

Centralizing investment licensing at the BKPM could also generate a hostile bureaucratic climate for investment ventures in the regions, and this will sabotage one of the primary objectives of local autonomy -- to encourage regional administrations to compete for investment.

The central government should instead delegate most of its licensing authority to regional administrations, with the BKPM retaining authority only for those requirements that need national standards, such as the environmental impact analysis, tax incentives, etc.

Instead of centralizing the overall investment licensing in Jakarta, which is after all contrary to the spirit of local autonomy, the government should help empower regional investment offices -- Provincial Investment Coordinating Offices (BKPMD) -- to enable them to better serve businesses and woo new investors through business-friendly policies.

Many local administrations still don't fully realize the great contribution of investment to their local economies through job creation and the injection of purchasing power to fuel consumer demand, thereby generating growth in the manufacturing industry.

Investors need expedient procedures for obtaining all the permits and facilities needed for their ventures, but the method of addressing this need should not kill the incentive for regional administrations to compete with each other in wooing domestic and foreign investment.

However, there are still escape clauses in the law that can help the government avoid past mistakes regarding the BKPM and the bureaucratic machinery for investment licensing.

The new investment law, which will replace the 1967 Foreign Investment Law and the 1968 Domestic Investment Law, stipulates that technical details on the implementation of the one-stop licensing and service center for investors, and on the division of public administration authority in the management of investment, shall be governed by presidential regulations.

Hence, like most other laws in the country, the key to the efficacy of the new investment law will depend on the provisions in the presidential regulations which, according to Trade Minister Mari Elka Pangestu, will be issued.

Is central bank really monitoring foreign exchange?

Friday, March 23, 2007 Vincent Lingga, The Jakarta Post, Jakarta

We now worryingly doubt Bank Indonesia's capability to monitor foreign exchange (forex) flows to and from the country.

This doubt arose after the recent disclosure of state-owned Bank Negara Indonesia (BNI)'s failure to report to the central bank the transfer of over US$10 million of Hutomo "Tommy" Mandala Putra Soeharto's money from the London branch of BNP Paribas to Indonesia through the BNI Tebet, South Jakarta, branch office, in June, 2005.

Yet more confusing are the remarks made by Bank Indonesia's executives about the transaction, as quoted by Koran Tempo in its March 21 issue.

Bank Indonesia spokesperson Filianingsih Hendarta was quoted as saying that Bank BNI might consider it unnecessary to report the money transfer to the central bank because there might have been nothing suspicious about the transaction.

One found it too flabbergasting that Filianingsih seemed entirely unaware of a ruling issued by Bank Indonesia in March 2000 that required bank customers in Indonesia, including foreigners holding stay permits and Indonesians residing overseas, to submit to the central bank, through their banks, detailed reports on every foreign exchange transaction in excess of US$10,000.

The Bank Indonesia ruling, which enforces the 1999 Foreign Exchange Flow Law, also requires that such reports disclose the remitter and recipient of funds, the type and purpose of the transaction and financial relationships between the transactors.

The explanation given by Wimboh Santoso of Bank Indonesia's directorate for banking development to the same newspaper is even more dumbfounding.

Santoso said banks were not required to report any financial transactions to the central bank but should report suspicious transactions to Indonesia's financial intelligence unit or the Financial Transaction and Report Analysis Center (PPATK).

The compulsory reporting on forex transactions was designed to keep Bank Indonesia apprised of capital flow to and from the country and to enable it to implement a more effective monetary policy.

Banks are obliged to keep detailed accounts of forex transactions they conclude for themselves and their customers because they have to submit a monthly report on their forex deals to the central bank.

Indonesia has held firmly to the regime of open capital account that allows free flow of foreign exchange to and into the country.

However, the financial crisis that set off massive runs on the rupiah and a massive capital flight out of the country between mid-1997 and 1998 made the government suddenly aware of the need to make sure the monetary authority was kept posted on foreign exchange flows.

During that crisis the central bank was completely in the dark about foreign exchange flows.
Hence, the birth of the 1999 foreign exchange flow Law. Up-to-date reporting provides the central bank with accurate, comprehensive and timely data on forex deals to enable it to have a better view of the position of the external balance and to anticipate speculative attacks on the rupiah.

The March 2000 ruling was supplemented with another Bank Indonesia regulation in July 2005, which limits foreign exchange derivative transactions with foreign counterparts against the rupiah to a maximum $1 million, down from a previous total of $3 million, and caps dollar purchases in outright forward transactions and swaps at $1 million.

The foreign exchange policy measure also imposes a three-month minimum investment hedging period on foreign exchange transactions. This means that investors with underlying investments in Indonesia must keep their funds in the country for at least three months.

The question is, though, how could Bank Indonesia ensure the proper implementation of the latter ruling on such complex forex deals if it miserably failed to detect even such a simple transaction as the $10 million transfer through the Bank BNI Tebet branch?

The central bank also seemed unable to properly enforce a regulation that requires commercial banks to know their customers with regards to detecting suspicious transactions.

The fact that Tommy's money was transferred not to his own account, nor to the account of a company he owned, but to an account in the name of a directorate general at the Justice and Human Rights Ministry meant that BNI completely ignored the "know-your customer" regulation. This also violated the provisions of the 2002 Anti Money Laundering Law that called for tough scrutiny of suspicious transactions.

The BNI should have been suspicious about the transfer and should have reported it to the PPATK because the transfer "looked strange" and was not supported by any underlying transactions.

The transfer should have caused BNI executives to ask what was the business of the Justice and Human Rights Ministry with the BNP Paribas branch in London.

The BNI cannot hide behind the banking secrecy clause for its failure to report to Bank Indonesia the transfer of Tommy's money and to inform the Indonesian financial intelligence unit of that suspicious transaction for further analysis.

If the conduct of BNI, a state-owned bank that is listed on the Jakarta stock exchange, is any guide, then we should really be worried how hopelessly feeble our anti-money laundering efforts have been.

Indonesia could face the bigger risk of being internationally blacklisted again as a haven for dirty money and a high-risk country for financial transactions.

Condition critical: Economic reforms cannot wait

Monday, March 12, 2007 Vincent Lingga, The Jakarta Post, Jakarta

Reform is never easy when it requires changes to an entrenched economic system. That is why broad-based reforms often require a crisis or perception of crisis, or at least a sense of chronic deterioration. It was economic crisis that brought down Soeharto in May 1998 and ushered in the reform era.

And we are once again mired in a critical condition now, despite the macroeconomic stability the government often boasts of.

With unemployment and underemployment estimated at some 40 million and the number people living on less than US$2/day exceeding 100 million, our situation is clearly critical.
But both the government and the House of Representatives have yet to demonstrate a sense of crisis in accelerating the reform measures sorely needed to reinvigorate investment, generate jobs and lift people out of poverty.

We had expected good sense to prevail in the end, but the Susilo Bambang Yudhoyono administration, currently in the middle of its term, has yet to demonstrate a feeling of urgency toward policy reforms in priority areas.

The experiences of other countries that have been successful in pushing through broad reforms shows that the timing of reform depends on political leadership - the leadership to make it clear that there is a crisis.

The government moved decisively in October, 2005 to reform the energy sector by slashing fuel subsidies through a 125 percent increase in fuel prices after the rupiah had come under fierce attacks by speculators.

This move immediately gained rewards from the market in the form of confidence in the rupiah and has substantially increased the government's fiscal capacity.

But it is rather mind-boggling to notice how apparently ignorant the government and politicians at the House have been for not being able to identify the crisis conditions that should have forced them to accelerate reforms.

Look how deliberations of the taxation, labor, investment and mining bills, already several years behind schedule, have been protracted, stuck on issues that are not very important to stimulating economic efficiency. Likewise, reform in public administration, including local governments and state companies , has been quite slow.

The challenges lie on two fronts. While the pace of reform legislation has been much slower than expected, the implementation of reform measures is even more disappointing. The cascading impact of this delay is a disappointingly slow recovery in public and private investments.

The government was commended for the comprehensive reform packages in infrastructure and investment it launched in the first quarter of last year. However, their implementation has dragged.

The crash program to construct 10,000 megawatts in additional power generation capacity seems to have crashed amid bickering about tender procedures and allegations of corruption.

The negative impact of the slow pace of reform is already being felt in the quality of growth as the number of jobs created by one unit of economic growth is now much smaller than before 2000.

The steady rise in unit labor costs in excess of productivity and rigid labor regulations have prompted new investors to economize on labor by avoiding labor-intensive businesses.
Banks, whose function is supposed to center on lending, prefer plowing their funds into debt instruments that have nothing to do with financing real economic activities.

Inefficiency and rampant corruption within the public sector, notably in tax, customs and business licensing, remain the most serious obstacles to new investment and the main source of business risk.

We often fail to realize that besides legal uncertainty, which makes it extremely difficult to do a reasonable risk calculation, corruption is also a source of unpredictability because any deal could be undone by someone bribing someone in the government.

President Yudhoyono received a strong political mandate in 2004 from disillusioned people who want things to change, but he seems unable to show the leadership necessary to translate this broad dissatisfaction into concrete action and move things in the direction the people want.

Idle funds threaten macroeconomic stability

Wednesday, March 07, 2007 Vincent Lingga, The Jakarta Post, Jakarta

The banks will publish their audited financial statements for 2006 within the next few weeks. The statements will mostly show bigger profits, but that doesn't mean the banks' managements should be commended for jobs well done.

The credit should instead go to Bank Indonesia, the nation's central bank, which had "been forced" to contribute more to banks' earnings.

Bank Indonesia Governor Burhanuddin Abdullah should indeed feel frustrated, since the new package of regulations he issued early last year to encourage bank lending has turned out to be ineffective. He should now work harder to soak up excess liquidity by issuing more Bank Indonesia Certificates (SBIs) and paying quite dearly for this instrument.

Even though many businesses are starved of finances, most major banks still prefer investing their excess funds in debt market instruments, notably risk-free SBIs and government bonds, instead of pumping them into the real economy.

It is unusual for a central bank governor to be so straightforward in airing a pessimistic outlook. But that was what Burhanuddin did last week. Apparently fed up with the slowness of the government's implementation of its reform policies, he sounded the alarm bell, warning of a weaker economy if banks remain inordinately risk-averse in their lending operations.

It is indeed a frustrating job for the central bank governor because, the more banks invest in SBIs, the higher the cost of Bank Indonesia's monetary market operations. He estimated the interest costs of SBIs this year alone at Rp 25 trillion.

While major banks pay only between seven to eight percent interest on time deposits, SBIs pay 9.25 percent. No wonder banks prefer investing their funds in SBIs. They can get more than 1.25 percentage points in interest revenue without doing anything. But investing in SBIs contributes nothing to economic growth.

As of last month, outstanding SBIs totaled almost Rp 240 trillion (US$25.8 billion). Burhanuddin estimated this amount could increase to over Rp 300 trillion by later this year if bank lending did not expand significantly.

The central bank governor certainly realized he could not jawbone commercial banks to expand their lending if business risks remain high and the overall investment climate remains highly adverse. Even the reduction of the central bank's benchmark short-term interest rate to 9 percent Tuesday will not be effective in prompting more lending.

It would be a suicide for banks to aggressively lend to businesses with unusually high risks, especially now the central bank is imposing higher standards of capital and overall credit risk management.

There is no a panacea to stimulate credit expansion. Bank lending cannot be accelerated by decree. The most effective way to stimulate bank lending is to improve the overall investment climate. Without significant improvements in the business climate the risk of bank credits turning sour will remain high.

Excess liquidity at banks is inflicting another cost on the economy. The huge sum of funds invested in SBIs and government bonds impose risks on macroeconomic stability. This is because idle money can immediately be used as ammunition for speculative attacks on the rupiah in the foreign exchange market.

Even more worrisome is the fact that, due to the unfavorable business climate, most foreign investment entering the country now consists of short-term portfolio capital. This hot money, currently estimated at nearly Rp 590 trillion, including Rp 505 trillion in stock holdings, Rp 55.5 trillion in government bonds and nearly Rp 25 trillion in SBIs, is another source of ammunition for speculative trading on the foreign exchange and stock markets.

The 3.5 percent decline in the Jakarta stock market composite index Monday had nothing to do with Indonesian economic fundamentals. The fall was due to changes in foreign investor sentiment caused by a perceived increase in the downside risk of the U.S. economy and a possible rise in Japan's interest rate.

This development is just more evidence that Indonesia's financial market and rupiah have become highly vulnerable to speculative attacks. This has been due to the steady increase in the amount of excess liquidity at the banks and in foreign portfolio capital inflows.

It should be needless to remind the government that the most effective way to push this excess liquidity into the real economy -- where it can finance the construction of factories and infrastructure -- is to reduce the country's high business risk by passing more reforms.