Unlocking Public and Private Investmen : Role of Financial Sector
Fiscal Policy Agency, the Ministry of Finance of the Republic of Indonesia, has supported a series of conferences looking at Indonesia’s economic transition and issues related to the middle-income trap. This year’s program “Unlocking Public and Private investment” was the sixth conference and focused on the the role of financial sector development in escaping the middle-income trap.
A well-functioning financial sector is needed to facilitate investments that are required in Indonesia to support strong and sustainable economic growth. It is therefore essential that public policy supports the development of Indonesia’s financial sector. One of the fundamental steps for promoting the domestic financial sector role is through strengthening the role of domestic savings. The seminar concluded that Indonesia’s domestic savings and their role to fund investment still needed to be improved. Research from AIPEG showed that a significant private investment gap - in the order of 6% of GDP by 2025 - exists in Indonesia. To address this gap, there are many initiatives that could be considered.
Firstly, the Government can play a greater role toward promoting long term savings. Mandatory private savings in Australia and Indonesia’s own BPJS (Badan Penyelenggara Jaminan Sosial, the social security administrative body) are great examples. The BPJS presentation highlighted some challenges that are still faced by BPJS, namely coverage expansion, social security awareness and support to economic development. To address these challenges, BPJS should expand the number of participants, reduce the possibility of early pension withdrawal, and improve its investment governance structure. As for supporting economic development, BPJS has started investing in long term assets such as government bonds. The seminar suggested that BPJS increase investment in long term assets such as corporate bonds, asset backed securities, and other capital market instruments to reflect its role as a long-term institutional investor.
The ADB then shared its experience in setting up local currency markets in developing countries noting that such an approach can deepen a country’s financial sector and reduce currency risk exposure. To deepen local currency bonds, especially those issued by international agencies, there are several challenges that should be addressed: readiness of the underlying project, availability of hedging instruments, and possibility of using these bonds as collateral in central bank repo market operations.
Secondly, the Government can play a role in financial inclusion policies. Financial inclusion initiatives should be developed to ensure access to financial services for everyone, regardless of income or location. The Japanese postal savings experience as a way of providing financial inclusion was discussed, with BI then detailing its specific strategy to ensure that 75% of the Indonesian population has access to financial services by 2019. The Japanese experience also highlighted that financial inclusion initiatives contributed to the public participation in deposit and insurance products that can address not only inequality but also increase savings accumulation. The latter is very important for current Indonesia’s economy. On top of that, financial literacy should be increased through education starting from primary school. This would need joint collaboration with the Ministry of Education under the National Strategy for Financial Inclusion (Strategi Nasional Keuangan Inklusif).
Thirdly, innovative financial market products can be developed to address sector specific financing gap issues. For infrastructure investment financing, this can include using project bonds, asset-backed securities and special purpose vehicle structures to meet the needs of long-term investors and help pay for new infrastructure projects. During the discussions, there was a recognition that meeting long-term investor needs were very important for Indonesia in order to deliver long term infrastructure investments.
Fourthly, the important role development institutions can play in encouraging particular financial market policy outcomes was recognised. The Agence Francaise de Developement and the Asian Development Bank Institute shared specific examples of how they had supported green financing via credit lines and provided focused financing assistance to Asian SMEs. The ADB’s experience in several developing countries also underlined that due to the strategic role of SMEs, lending to this sector is very important. The key challenge to be addressed is the unavailability of integrated data management so that financial institutions can properly assess the SMEs credit risk. This could ultimately increase the possibility of lending. In Indonesia, the Ministry of Cooperation and SMEs could use this data to better deliver the subsidized credit program for SMEs (Kredit Usaha Rakyat).
Fifthly, providing adequate financing for infrastructure projects was explored. Discussions focused on the critical role the private sector plays in delivering infrastructure and recognized that PPPs have been a successful infrastructure delivery option in other countries. Key messages emphasized the importance of the Government having a clear plan; the private sector trusting the business environment; and communicating a ‘pipeline’ of commercially viable projects to potential investors. An interesting idea raised in relation to innovative PPP delivery was SOEs undertaking joint venture arrangements with private sector partners to deliver PPPs and leverage off each parties advantages. These are very important in order to increase the market for infrastructure.
Finally, the Forum recognized that while financial market development advances, the safeguarding of financial stability is critical. The seminar was fortunate to have Ms. Sheila C. Bair, former Chairman of the Federal Deposit Insurance Corporation, present her experience in the United States during the Global Financial Crisis. Some key messages from her presentation included: the importance of establishing early warning systems; having a financial safety net law; the existence of a strong deposit insurance institution; and the importance of coordination with other government agencies during a crisis. She also suggested that one of the most important post-crisis proposals for bail-in policies in the US is the requirement to keep a minimum amount of long-term debts in bank’s balance sheet. This direction is in-line with the “bail-in” approach in the newly adopted financial safety net law in Indonesia.
As mentioned by the Minister of Finance in her keynote speech, future challenges will include the risks of potential technological changes and economic inequality between regions in Indonesia. Specifically, the challenges are: (1) how to prepare our labor markets in the midst of rapidly changing technology and global environment so we can improve productivity, competitiveness, and reduce poverty and inequality; and (2) given a high reliance on fiscal transfer, we should take a look at the economic force and potential of each region so that we can design effective fiscal policy to reduce disparity between regions. These issues will be the topic for the next strategic research conducted in 2017 by BKF.