|Project Rationale and Linkage to Country/Regional Strategy
Financial sector reforms are crucial to raising Indonesia?s growth rate and to increasing the economy?s resilience. Since the Asian financial crisis in 1997, Indonesia has undertaken key financial sector reforms and has succeeded in restoring the banking sector to solvency and profitability. However, the rate of economic growth has not returned to pre-crisis levels. Indonesia needs investments, especially in infrastructure, but the domestic financial sector is not yet able to finance them. The financial sector is shallow and dominated by banks. Bank lending has not yet recovered to pre-crisis levels and banks? balance sheets make them unsuited to the nation?s need for long-term financing. The nonbank financial sector, in particular, the capital markets, although still small, offer a major opportunity to reinvigorate growth thorough more efficient intermediation.
The goal of the CMDP Cluster is to promote the diversification and resilience of the financial sector while supporting the medium-term macroeconomic goals of the Government. The Program supports the Government?s financial sector reform agenda by focusing on capital markets. Most of its policy outcomes will be in line with the Government?s financial sector policy package (FSPP) and its capital market master plan, 2005?2009 (CMMP).
The Program aims to strengthen transparency and information disclosure. This is essential to build confidence in capital markets and institutions, facilitate regulatory oversight, and, in turn, to promote price discovery and market liquidity. Both supply and demand sides of financial markets will be addressed. On the supply side, measures are proposed to deepen government bond markets, which are an essential building block for the development of corporate bond markets and inter-bank money markets. On the demand side, the investor base needs to be broadened by promoting institutional investors such as contractual savings and collective investment schemes. The Program aims to strengthen the underlying structure for securities trading, so markets can function with sufficient speed, efficiency and accountability. Deeper domestic capital markets and improved financial intermediation between savers and investors, supported by stronger regulation and supervision will increase the financial sector?s contribution to economic growth. Policy measures to improve financial governance and market efficiency, and to reduce systemic risks, are embedded in the Program and will help to strengthen investor confidence and the investment climate.
The reform agenda is structured around the following policy outcomes, which form the basis of the Program?s four components:
(i) enhancing information disclosure and price discovery;
(ii) promoting deeper and more liquid financial markets;
(iii) improving market surveillance and investor protection; and
(iv) strengthening governance and human resource capacity.
The Program consists of two single-tranche subprograms anchored on the Government?s financial sector reform programs. It will run from January 2006 to December 2010, with a single tranche loan of $300 million approved and disbursed under subprogram 1 (2006?2007) in December 2007. Subprogram 2 was expected to be ready for Board approval about 18 months after subprogram 1 becomes effective. The policy actions have been divided into two phases: January 2006 to September 2007 for subprogram 1 and October 2007 to June 2009 for subprogram 2. The Government?s medium-term reform agenda and its timing were reviewed in light of the achievements of subprogram 1 and reform proposals for the policy environment have been taken into account, supported by subprogram 2. Sub program 2 will comprise of a single tranche loan of $300 million and a technical assistance for $1,000,000 for strengthening governance and regulation
||The expected impact of the Program of which is capital market growth and diversification, combined with stronger regulatory and supervisory capacity. It is expected that the Program will lead to an increase in the nonbank financial sector?s share of total financial assets. The reforms, which concentrate on improving information disclosure and enhancing market surveillance, will provide more protection for investors. To provide a basis for consolidated regulation of the nonbank financial sector and to move toward more functional regulation, oversight of the capital markets was recently combined with oversight of the contractual savings industries on which they depend, principally insurance and pensions. This will be achieved through the recently merged Bapepam-LK (the capital market and nonbank financial supervisory authority) and is expected to be formalized under a regulatory framework now being developed. A new risk-based approach to supervision, which originated in banking and has already been applied to some securities intermediaries, will be applied to contractual savings institutions and other capital market institutions, thus reducing the risk of regulatory arbitrage