The government's medium-term reform priorities focus on the identified development constraints. First, the government seeks, in particular, to foster economic development by strengthening regulatory oversight. This in turn will increase stability and investor confidence. Also, the Capital Market and Nonbank Financial Industry Master (CMNMP) aims to deepen the capital market, expand access to nonbank financing, and broaden the investor base. To attain these objectives and build momentum for capital market development, the CMNMP provides a functional focus on increasing the linkages between the contractual savings subsector, the subsector dealing in funding arrangements that are compliant with Islamic sharia law, and the traditional capital markets. To support these reforms, the government has requested ADB assistance in the form of a policy-based program loan. The program will build on the government's accomplishments under the post-program partnership framework (P3F) of Subprogram 2 of ADB's Capital Market Development Program Cluster. To support these reforms, the government has requested a loan of $300,000,000 from ADB's ordinary capital resources. The loan will have a 15-year term, including a grace period of 3 years, an annual interest rate determined in accordance with ADB's London interbank offered rate-based lending facility, a commitment charge of 0.15% per year, and such other terms and conditions as set forth in the draft loan agreement.
Under output 1, the creation of the Integrated Financial Services Authority (OJK) was authorized in law in 2011 and the agency will be operational by the end of 2012. This initiative will provide for independent, harmonized, and comprehensive regulation and supervision of the financial markets. ADB has been a consistent supporter of this effort since 2002. In addition, Bapepam-LK has further enhanced its supervisory capabilities and those of the successor OJK by processing the revision of three primary financial sector laws on capital markets, insurance, and pensions to include resolution powers over problematic institutions and qualified supervisor immunity. Drafts of all three laws have been completed, socialized and entered into the national legislative agenda. Bapepam-LK has introduced risk-based supervisory practices to the contractual savings subsector and has continued to pursue regional integration initiatives that include the harmonization of standards. As part of these efforts, Bapepam-LK has participated in an initiative to introduce a common set of corporate governance standards in the Association of Southeast Asian Nations and has strengthened corporate governance standards in Indonesia in line with this effort. Programs to develop the capacity of the industry and financial regulators have been completed and will continue.
Under output 2, the government focused on coordinated, ongoing activities to strengthen the primary and secondary government debt market, including the market for sukok. Specifically, the Directorate General of Debt Management continued to consolidate government debt issuance around recognized benchmarks. To support the secondary market and to strengthen the conduct of monetary policy, Bank Indonesia discontinued issuance of Bank Indonesia bills, which were supplanted by Treasury bills beginning in 2011. Concurrently, Bank Indonesia began implementing monetary policy through open market operations with its own inventory of securities and repos/reverse repos with maturities of 1 week to 6 months. This reform includes measures to increase the proportion of tradable securities within the government's debt stock by beginning a process through which non-tradable bank recapitalization bonds will be converted to tradable status. To improve market efficiency, increase trading volumes, and strengthen risk management, a draft global master repurchase agreement, with applicable annexes, has been completed and will be introduced into Indonesia in 2013. To provide a greater number and variety of instruments to investors, measures were implemented to ease the securities issuance process and to encourage the use of municipal bonds by rationalizing existing regulations and harmonizing them with those governing the issuance of corporate debt. To improve the quality and transparency of financial information, Bapepam-LK has continued to progress towards full convergence with the International Accounting Standards and International Financial Reporting Standards. To strengthen investor protections, Bapepam-LK has launched an initiative to create a securities market investor protection fund and has increased participation in the investor area facility to provide investors with the ability to independently self-monitor their investment portfolios. Bapepam-LK has introduced a code of conduct for market intermediaries.
Under output 3, Bapepam-LK has simultaneously increased the contractual savings sector's demand for capital market products. Specifically, Bapepam-LK has encouraged participation in retirement planning by easing the rights issuance process, which benefits employee stock ownership plans, and by exempting investment income earned by pension funds from taxation. Bapepam-LK has also provided an enabling environment for the growth of takaful, a form of Islamic insurance, by issuing guidelines on the governance of takaful undertakings. Bapepam-LK has adopted and implemented basic principles and standards of financial soundness for shariah compliant insurance and reinsurance. To strengthen the conventional insurance industry, Bapepam-LK raised the minimum capital standards for insurance and reinsurance companies and has worked with the industry to improve pricing and risk management in the life and nonlife insurance subsectors. This included collaboration to develop updated mortality tables based on Indonesian data as well as minimum tariffs for auto insurance. To broaden the investor base, the government has encouraged the development of the Islamic finance sector by giving it the same tax treatment as conventional finance. Bapepam-LK revised the criteria for giving stocks sharia-compliant status. As a result, the number of sharia-based contracts expanded and the number of shariah-compliant securities increased. Bapepam-LK has strengthened governance in the contractual savings industry and increased investor confidence by strengthening the role of pension fund controllers' committees.
|Project Rationale and Linkage to Country/Regional Strategy
The overarching goal of the government's National Medium-term Development Plan for 2010-2014 is to make Indonesia a prosperous, self-reliant, and democratic country. To improve the welfare of the population through sustainable economic growth and to achieve the associated goal of reducing the poverty rate to below 10%, the government has established a cumulative investment target of Rp12,000 trillion-Rp12,500 trillion during this time period. A significant proportion of this investment is targeted to come from banks, nonbank financial institutions, and the capital markets. Despite progress in capital markets development, the local currency government and corporate bond markets in Indonesia represent, in the aggregate, less than 15% of GDP and remain very small compared with those in regional peers Malaysia and Thailand, where bond markets exceed 65% of GDP. The contractual savings sector also remains small, with insurance premiums representing less than 2% of GDP. If Indonesia is to meet its internal investment targets, more needs to be done to deepen the financial sector and to establish vibrant nonbank financial institutions.
Boosting the role of the contractual savings subsector as a source of potential demand for capital markets products is particularly important and needs to be encouraged. For example, the interconnections between contractual savings, capital market development, and economic growth are not deeply understood by the public or even segments of the government and the private sector. The government and stakeholders in the private sector need to jointly encourage growth in long-term savings by providing tax incentives, improving the governance of the sector, and adopting more effective asset allocation methodologies. Other constraints on Indonesia's capital markets are a lack of risk management tools, burdensome regulatory requirements, and limited transparency. Low domestic investor confidence and high volatility brought about by dominant levels of foreign participation have limited domestic participation in the capital markets. The need to address these issues and to modernize the regulatory structure has become even more urgent due to an increase in inward capital flows associated with the country's credit rating upgrade and the need for infrastructure funding.
The cost to Indonesia of limited financial sector development can be measured in terms of forgone economic benefits. The link between economic growth, private credit and stock market liquidity is well known and is empirically supported. Studies indicate that contractual savings also play a large role in fostering economic development. By increasing the links between contractual savings and the other financial subsectors, Indonesia's economy can benefit from lower information and transaction costs, pooling of risk, increasing efficiency of capital allocation, and enhanced intermediation. This same research indicates that the boost to economic growth achieved by increasing the penetration of life insurance will be even more pronounced given higher levels of bank credit to GDP and stock market liquidity. Using studies by Levine and Zervos done in 1998 and Marco Arena in 2008, and the World Bank's Financial Development and Structure Database, ADB staff estimated that Indonesia's real GDP per capita would have been $1,300 in 2010, or 14% higher than the actual $1,144, if the level of bank credit intermediation had been equal to the average of the data base in each year over the period 1990-2010. Similarly, real GDP per capita in 2010 would have risen to $1,335, or 17% higher than the actual if the level of bank credit intermediation and stock market liquidity had been equal to the average of the data base in each year over the period 1990-2010. Finally, combining an increase in bank credit intermediation and stock market liquidity with an increase in insurance penetration during this same period would have increased real per capita GDP in 2010 to $1,700, representing an increase of almost 50% over the actual.