Why Indonesia is positive it can reach its potential

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Moreover, some of the headline numbers that seem to show cause for alarm look better when placed under greater scrutiny. First, the banking sector, the area under perhaps the greatest pressure of all over the last 10 years. “The banking system is solid now,” says Tigor. “If you look at all the big banks, their capital ratio is strong. Their NPL [non-performing loan] ratio is rising but at a manageable level. The Asian crisis taught us all a lesson and there’s a lot of knowledge transfer from groups like Temasek [that have bought into Indonesian banks].”

Consequently, and extraordinarily, many Indonesian banks actually grew, both in terms of profitability and loan book, in the fourth quarter of 2008 as the rest of the world’s financial systems fell apart. Take Mandiri, the biggest: on almost every metric, 2008 was a record year for it. Year on year by December 31 its total assets were up 12.4%, deposits 16.9% and loans 25.9%. Moreover, loans and deposits both grew considerably in the fourth quarter. “It’s no surprise that in terms of valuation the Indonesian banks are the most expensive in the world,” says Wong. “They’re trading at two times price to book and are also the most profitable in terms of return on equity.”

It’s true that Indonesia had real concerns last year about the health of this sector, which was visible in the state of the interbank market, which fell from its pre-crisis levels of around Rp250 trillion in transactions per month to as low as Rp70 trillion. But that indicator has bounced strongly, to Rp197 trillion in March. “It halved, but now it is recovering and is almost at pre-crisis levels,” says Helmi. “The sense of systemic risk concerning the banks has been reduced greatly.” On the NPLs side, Sailesh Jha at Barclays reckons that should top out at 5 to 7%, with only “modest pickup. Because balance sheets are stronger at the banks they are in a position to be more flexible with the corporate sector, which means they are interacting and working towards solutions so corporates don’t tend to default.”

There is near consensus that at the top level of 10 to 15 banks, all is well. But the problem with Indonesia is there aren’t just 10 to 15 banks, but 126. Granted, this is much less than the 240 of 1994, but it is still a strikingly long tail and there are widespread concerns about the ability of Bank Indonesia to supervise it all appropriately.

Bank IFI in and of itself was insignificant: it was one of the country’s smallest banks. Bank Century was bigger, but also not structurally significant when it ran into trouble and was bailed out by Bank Indonesia and the government after liquidity problems late last year. But if enough smaller banks run into trouble simultaneously, that’s going to cause problems. “The worry has always been that two or three of them could have a problem at the same time,” says Wallace. “None of them would be a systemic problem in and of themselves, but if any group of them were to have problems that would send a bad signal.”

One issue is that the smaller banks in particular have been behind a trend to offer exceptionally high deposit rates – in some cases higher than they appear to be able to back with assets. There is another problem with this arrangement: while the Ministry of Finance has a guarantee program in place for Indonesian deposits, it only covers assets in accounts with deposit rates up to or below a set rate, and most of these small bank accounts are not covered.

Ideally Bank Indonesia would like to see further consolidation take place but it’s not obvious how this will happen. A bank of Mandiri’s scale grows its assets by the size of even the biggest second-tier banks in a year or less, so there’s not much incentive for big banks to acquire franchises when it will probably grow them organically anyway. Some would like to see a Malaysian approach: “We’re going to shut you all in a room, and one way or another we want you to come out as 10 banks.”

The external debt situation also seems to have faded as a worry. It was the corporate debt that seemed to be causing the greatest concern, but much of this is owed to affiliated parties – a global parent like Unilever or Toyota – and is therefore not in risk of a refusal to roll over. Also, the corporate bond markets are open, if difficult; banks do appear to be lending; and there has not yet been a sign of obvious distress. “The balance of payments for the last quarter of last year show the corporate sector still managed to draw down more than they repaid in external debt – when everyone else is deleveraging,” says Helmi at Danamon. “We take that as a positive sign.” Wallace adds: “They have rolled over a much higher fraction than we were concerned about in the first quarter. It has not played out as badly as we feared.”

Chris Wright
Chris Wright
Chris is a journalist specialising in business and financial journalism across Asia, Australia and the Middle East. He is Asia editor for Euromoney magazine and has written for publications including the Financial Times, Institutional Investor, Forbes, Asiamoney, the Australian Financial Review, Discovery Channel Magazine, Qantas: The Australian Way and BRW. He is the author of No More Worlds to Conquer, published by HarperCollins.

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