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Cablegate: Indonesia - Obstacles and Progress in Capital Market

VZCZCXRO1667
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #3296/01 3370732
ZNR UUUUU ZZH
R 030732Z DEC 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 7238
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 1226
RUEHBJ/AMEMBASSY BEIJING 4546
RUEHBY/AMEMBASSY CANBERRA 1678
RUEHUL/AMEMBASSY SEOUL 4320
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 003296

SIPDIS

SENSITIVE
SIPDIS

DEPT FOR EAP/MTS, EAP/RSP AND EB/IFD/OMA
TREASURY FOR IA-BAUKOL, OTA-MCDONALD
SINGAPORE FOR TREASURY-BAKER
COMMERCE FOR 4430-BERLINGUETTE
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN
DEPARTMENT PASS EXIM BANK

E.O. 12598: N/A
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: INDONESIA - OBSTACLES AND PROGRESS IN CAPITAL MARKET
DEVELOPMENT

REF: A) Jakarta 978 (Insurance Sector);
B) Jakarta 1128 (Monetary Policy Instruments);
C) Jakarta 3099 (Foreign Restrictions on SBI)

1. (SBU) Summary: Tax, legal and accounting issues are impeding the
development of securities markets and products in Indonesia. Market
participants and some regulators argue that the lack of hedging
instruments and financing techniques is the key obstacle to
securities market development. On the positive side, regulators are
starting to research initiatives to improve the insurance industry,
including addressing long-time insolvent firms. Civil service
reform is also reducing opportunities for rent seeking, which may
improve both regulation and corporate governance. Indonesian
securities supervisors have requested help from the U.S. Securities
and Exchange Commission (SEC) in improving disclosure and market
surveillance (see para 15) and the SEC plans to respond to the
request with a visit in early 2008. End Summary.

T-Bills and SBI
---------------

2. (U) Indonesia's banking sector suffers from chronic excess
liquidity. BI issues Sertifikat Bank Indonesia -SBIs - as part of
open market operations. BI uses SBI as sterilization and liquidity
instruments with one- and three-month maturity. (See reftel B.) Due
to the limited supply of alternative financial assets, overseas
investors buy SBI, which reduces the effectiveness of BI's liquidity
management activities. Despite Indonesia's progress in setting up a
primary dealer's market and holding its first T-Bill auctions in
2007, the Ministry of Finance has not yet issued T-Bills with less
than one-year maturity. The expansion of availability of short-term
T-Bills would not only help market development by filling in the
short end of the yield curve, but would also provide a new monetary
policy instrument besides SBI.

3. (U) Currently, a 20% up-front tax hit on T-Bills appears to be a
small - but not insurmountable -- disincentive for many investors
and securities dealers. However, Bank Indonesia (BI) is refusing to
pay withholding tax on T-Bills, and therefore will not purchase them
for use as monetary instruments. One bond market expert noted that
taxing a central bank on purchases of government bonds had virtually
no precedent anywhere in the world.

4. (SBU) The availability of T-Bills is an important aspect of the
debate on potentially limiting foreign ownership of SBIs (reftel C).
Without other short-term, rupiah-denominated securities such as
T-Bills, for foreign investors to switch into, limiting foreign
ownership of SBIs could potentially be destabilizing to the currency
markets. Official sources told us, however, that there are plenty
of ways to "work around" such a regulation, should BI ever issue it.
Most view such a move as unlikely and BI officials confirmed in
meetings with the Embassy that it has no plans to restrict foreign
ownership of SBIs or introduce capital controls in the near term.
Nevertheless, many market participants continue to believe it would
be in Indonesia's best interest to exclude non-resident investors
from the SBI market. Should foreigners ever be excluded, the GOI
could potentially reduce any adverse impact by issuing more T-Bills
to capture this demand.

Hedging Instruments Needed, Especially Repo Market
--------------------------------------------- -----

5. (SBU) Deutsche Bank's Director for Fixed Income Trading, Francis
Soetopo, argued that the main problem in the bond market now is the
absence of hedging instruments. He argued that providing hedging
instruments should be the top priority from a regulatory point of
view.

6. (SBU) The most important hedging tool would be a properly
functioning repo market. According to Citibank Country Economist
Anton Gunawan, BI officials want to rely on the private sector to
develop a repo market so that BI will not have to be the
counterparty to every repo transaction, thus reducing its own risk.
However, debt officials told us that the private sector's Master
Repo Agreement drafted previously is not working due to accounting
and tax problems. Reportedly, banks that engage in repo agreements

JAKARTA 00003296 002 OF 003


are not able to effectively remove the liability from their balance
sheet even when it is has been sold to others. Furthermore, repo
transactions are subject to transfer taxes, even if the assets
revert back to their original owner at the end of the repo deal.

7. (SBU) JP Morgan Managing Director Rizal Prasetijo also argued
that international financial institutions are required to limit
counter-party risk associated with local Indonesian banks. This
means that the lines of credit available in local bank-to-bank repo
agreements would be very small. He argued, therefore, that Bank
Indonesia will have to be the counterparty for the foreseeable
future if they want to have a deep and liquid repo market. However,
even if BI were to seek a direct role as counterparty in repo
transactions, they are unlikely to warehouse the variety of
inventory required or want to disburse and/or absorb large cash
balances at the request of the dealer community.

Hope for Progress after Stock Exchange Merger
---------------------------------------------

8. (SBU) BAPEPAM Chairman Fuad Rahmany believes that the merger of
the Jakarta (JSX) and Surabaya Stock Exchanges (SSX) will set the
stage for development of better derivatives markets, although there
will be some rough patches during the transition period. The merged
exchanges, legally effective on November 30, are now called the
Indonesia Stock Exchange (Bursa Efek Indonesia or BEI). Previously
the SSX, which specialized in bond trading, wanted to explore
derivatives (futures, options, real-estate investment trusts) but
the underlying asset was often traded on the larger, more liquid
JSX. Trading related securities on different exchanges creates
problems in coordinating market surveillance to guard against market
manipulation. As soon as the merged entity is stable, one bond
market official predicted that the MOF and BAPPEPAM would roll out
bond futures early next year. The SSX was already in the advanced
stages of developing a financial futures contract for government
bonds.

Addressing Taxation of Securities
---------------------------------

9. (SBU) Rahmany also mentioned that tax was the biggest hurdle in
terms of securitization products, such as asset-backed securities.
In addition to tax, real estate investment trusts (REITs) and
mortgage backed securities are also held up by the national land
agency, BPN. Two new government regulations are needed to address
land title issues, custodial titles, the structure of new products
and their tax treatment.

10. (U) The government does seem to have recognized the myriad of
tax problems holding back market development. In response, Dr.
Anggito Abimanyu, Head of the Ministry of Finance Fiscal Policy
Office said that the Ministry of Finance is drafting a new law in
2008 to address tax treatment of:

-- Financial securities (which he noted were not covered under
income tax);

-- Sharia bonds and other sharia investment instruments;

-- Derivatives and asset-backed securities.

Diversifying and Shoring Up Domestic Bond purchasers
--------------------------------------------- -------

11. (SBU) Rahmany said plans also were being developed to encourage
more domestic players to participate in bond markets. One market
expert reported that most insurance and pension assets are invested
in shorter-term bank deposits rather than longer-term assets such as
government or corporate bonds. This is partly due to regulatory
rules that count 12-month deposits, but not government bonds, as
regulatory reserves.

12. (SBU) Most observers believe that the resulting asset-liability
mismatch has been allowed to persist due to concern about the
solvency of a few large firms and pension funds. Rahmany admitted
that the insurance regulator had been weak, and the Ministry of

JAKARTA 00003296 003 OF 003


Finance is now trying to compensate for past neglect. At the
industry level, former Coordinating Minister for the Economy
(2001-2004) and Indonesian Ambassador to the U.S. (1998-2001)
Dorodjatun Kuntjoro Jakti agreed to chair a "Blue Ribbon Commission"
on insurance reform, long requested by international insurers in
Indonesia to examine ways to improve the laggard sector. Terms of
reference for the Commission are being drafted and will be submitted
to BAPEPAM-LK for comment in the coming weeks.

GOI Confirms It Will Bail Out Large Insurer
-------------------------------------------

13. (SBU) More narrowly, Rahmany confided that the GOI was looking
for ways to bail out bankrupt insurer Bumiputera 1912 (reftel A),
which has around 6 million policy holders. Due to the size and
sensitivity of the bailout, Rahmany asked for our discretion, noting
that it will be a very sensitive issue, requiring a presentation to
Parliament, with a request to spend public money on the bailout.
Despite its government connections - historically many rural civil
servants supplemented their wages by selling its policies for
commissions -- Bumiputera is technically a mutually-owned life
company, not a state-owned company. "Eventually, we will have to
demutualize it," Rahmany said. As Bumiputera 1912 is also the only
mutual life insurance company in Indonesia, that path will be
challenging.

Some Progress on Reducing Rent Seeking
--------------------------------------

14. (U) Civil service reform is helping to reduce some incentives
and opportunities for rent seeking by regulators and other
government officials. First, under the leadership of Finance
Minister Mulyani and BAPEPAM Chairman Fuad Rahmany, salaries have
tripled for BAPEPAM employees and raised significantly for high
level Ministry of Finance officials (particularly those in Echelon
1). Secondly, Ministry of Finance Head of Fiscal Policy Anggito
Abimanyu - who also sits on the board of PT Telkom, Indonesia's
state-owned telecom company -- reported that a new policy requires
government employees to refuse salaries provided as members of
boards of directors or commissioners. The new policy applies to the
Ministry of Finance, the Supreme Audit Board (BPK), and the Supreme
Court this year and is planned for the armed forces, police and
judges next year. According to the plan, all central government
officials will have to refuse any additional corporate salaries by
2012.

SEC Assistance Sought
---------------------

15. (U) Rahmany said that BAPEPAM is grateful for assistance from
the U.S. Treasury, the U.S. Securities and Exchange Commission, as
well as Australia's Securities and Investment Commission (ASIC).
Rahmany requested that the SEC team he requested for a review of
market enforcement tools, come as early as possible in 2008.
Rahmany would also like to see a review of the disclosure rules for
listed companies. "There is a lot of misbehavior in our markets,"
Rahmany acknowledged. He seeks SEC assistance with two major items:
the enforcement process including the Attorney General's Office
(AGO) and techniques and analysis to review suspected cases of
market manipulation. State, Treasury, IMF, SEC, and the Australia's
Technical Assistance Management Facility for Economic Governance
(TAMF) have been coordinating on assistance to BAPEPAM.

HUME

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