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Cablegate: Indonesia's Capital Markets Weathering Turmoil

VZCZCXRO4391
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #3138/01 3170748
ZNR UUUUU ZZH
R 130748Z NOV 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 7017
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 1096
RUEHBJ/AMEMBASSY BEIJING 4470
RUEHBY/AMEMBASSY CANBERRA 1535
RUEHUL/AMEMBASSY SEOUL 4286
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 003138

SIPDIS

SIPDIS

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-SSEARLS AND JWEEKS
SINGAPORE FOR SBAKER
TOKYO FOR MGREWE
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'S CAPITAL MARKETS WEATHERING TURMOIL


1. Summary. Dr. M. Chatib Basri, a well-respected macroeconomist,
stated that Indonesia has weathered recent turmoil in global
financial markets and is unlikely to face another significant
financial crisis in the near term at a seminar on November 6. Bank
Indonesia (BI) Senior Deputy Governor Miranda S. Goeltom underscored
the need to deepen capital markets. Ministry of Finance (MOF)
Fiscal Policy Agency Head Anggito Abimanyu noted that the Government
of Indonesia (GOI) continues to strive to improve market monitoring
and establish liquid, transparent, and orderly capital markets. The
MOF remains concerned about potential spillover from the subprime
mortgage crisis in the United States and high oil prices. Despite
recent financial market turbulence, foreign investors have remained
invested in Indonesian assets.

Macroeconomic Outlook Strong,
But Unemployment Persists
----------------------------

2. On November 6, the United States-Indonesia Society (USINDO)
hosted a seminar on "Capital Market Development: What Does the
Future Hold?" Prominent Indonesian policymakers and economists
addressed and attended the forum. Dr. M. Chatib Basri, an advisor
to the government, respected macro-economist and University of
Indonesia faculty member, observed that Indonesia has weathered
recent turmoil in global financial markets and is unlikely to face
another significant financial crisis in the near term. Both the
stock market and yield curve have returned to the levels witnessed
prior to the onset of global credit market problems. The Indonesian
banking sector remains strong, foreign exchange reserves are high
and the country has low levels of short-term foreign currency debt.
He also emphasized Indonesia's strong macroeconomic outlook. Basri
believes that investment rates bottomed out in 2006 and will
continue improve in the coming 12 months, albeit at a less than
optimal pace. Supporting this view are strong capital goods
imports, increased electricity use and an increase in value-added
tax (VAT) revenues.

3. Dr. Basri noted that government statistics often underestimate
the level of economic activity in Indonesia. Most small businesses
prefer to avoid government officials in an effort to escape official
graft and bureaucratic red tape. Basri also asserted that while
domestic and international demand for Indonesian products is high,
the economy suffers from significant supply side constraints,
particularly in labor-intensive industries. As a result,
manufacturing and other labor-intensive industries have not
responded to lower interest rates and the open unemployment rate
remains high. In order to remove these supply side constraints, the
government needs to reform labor laws and to improve the investment
climate. He also noted that investment climate reforms are
necessary -- but not sufficient -- conditions to attract investment.
Indonesian companies must also position themselves to become part
of the supply network for global products, similar to India and
Malaysia.

Challenges Ahead for Bank Indonesia
-----------------------------------

4. BI Senior Deputy Governor Miranda S. Goeltom outlined the current
challenges faced by monetary policy makers in Indonesia and
underscored the need to deepen capital markets. Despite Indonesia's
positive economic outlook, Miranda believes Indonesian policymakers,
particularly central bankers, must move cautiously in light of the
large amount of uncertainty surrounding global capital markets. The
amount of losses and full market impact associated with the U.S.
subprime mortgage debacle is still unknown. Miranda expressed
concern that a downturn in the United States could have both primary
and secondary effects on Indonesia, through direct trade and trade
with other US trading partners such as China and India. Miranda
also expressed concern about the effect of high oil prices on
Indonesian inflation rates. Because Indonesia produces and imports
oil, the impact of higher oil prices on the Indonesian economy
remains difficult to forecast.

5. In Miranda's view, Indonesia needs to develop capital markets to
smooth out potential volatility and channel funds more efficiently
to the real sector. Indonesian domestic capital markets have the
lowest level of market capitalization in the region with the

JAKARTA 00003138 002 OF 002


exception of the Philippines. With relatively underdeveloped
capital markets, Indonesia is more vulnerable to changes in market
sentiment. In addition, without deep capital markets, Indonesia
continues to rely on banks to finance most economic activity. Yet
Indonesian banks have focused the bulk of their lending in the
capital-intensive natural resource sector, creating few jobs in the
process. She urged government policy makers to accelerate legal
reforms and introduce incentives to initial public offerings and
corporate bond issuance that would help spur growth in debt and
equity instruments. She also commended the Ministry of Finance's
(MOF) efforts to create a more complete yield curve in Indonesia
through Treasury bill auctions.

MOF Focused on Capital Market Deepening
---------------------------------------

6. MOF Fiscal Policy Agency Head Anggito Abimanyu, in a presentation
entitled "Debt Financing and Deepening Capital Markets," described
the GOI's efforts to improve market monitoring and establish liquid,
transparent, and orderly capital markets. The MOF now uses
Bloomberg-based system to monitor Indonesian financial market
developments on a real time basis. The MOF can plot the impact of
capital market developments on Indonesia's budget, including the
effect on revenue, subsidies and the budget deficit. The system
also assess overall economic conditions in Indonesia, issuing a
warning sign to indicate whether the operating environment is normal
(green), cautious (yellow), or poor (red).

7. On the fiscal policy side, Anggito highlighted the MOF's work to
develop the T-bill market, which has allowed the GOI to expand its
budget deficit and tap domestic financing sources, reducing the
external component of the national debt. Anggito also noted that
the government securities market is increasingly diverse, with a
range of long-term and short-term instruments. The MOF has fully
embraced a market-based, disciplined debt management strategy,
communicating regularly with the market participants. Looking
forward, the GOI also hopes to issue sharia bonds next year in an
effort to take advantage of demand for GOI debt in the Middle East.
The MOF is also preparing to reduce taxes for initial public
offerings in an effort to boost equity market development.

8. Anggito noted that the MOF is closely monitoring the current
instability in capital markets, and remains concerned about
potential spillover from the subprime mortgage crisis in the United
States and high oil prices. While recent global market instability
has increased volatility of foreign capital markets, foreigner
portfolio investors have not retreated significantly from Indonesian
markets.

HUME

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