Treasury Today Country Profiles in association with Citi

Indonesia: making the grade

Indonesia

With its credit rating upgraded to investment grade and an enviable GDP growth rate of around 6%, Indonesia is attracting interest from MNCs. In addition, its growing domestic purchasing power is helping the country overcome historical infrastructural challenges.

In April, Indonesia’s President, Susilo Bambang Yudhoyono, urged multinational corporations (MNCs) in the country’s natural resources sector to engage in “genuine partnership and cooperation”. Speaking at a Reuters event in Singapore, he said many MNCs around the world “take too much and do not leave behind enough for the people of those countries”.

Indonesia is a major exporter of copper, nickel, gold and other commodities such as palm oil, oil and gas. The government has implemented a range of policies to encourage companies to invest more in downstream businesses and to add value to products before they are exported. At the same time, it is looking to expand the country’s manufacturing base.

In June, the Indonesian government announced a new tax of 20% on mineral exports of unprocessed metals. The Financial Times reported that companies without plans to build processing facilities onshore would be banned from exporting.

“Indonesia realises it has a large population that makes it an attractive domestic market for MNCs,” says Andy Dyer, Head of Transaction Banking Sales in Asia Pacific, Europe and Americas at ANZ Banking Group. “It doesn’t just want to be an export market based on cheap labour. Recent regulations are geared towards adding value to exports, particularly in the resources sector.

“Regulations have been designed to make it more difficult for the extractive industries to export without adding value. You could argue this might put some companies off entering the market, but the country has very strong fundamentals in terms of demographics and resources.”

In January, ratings agency Moody upgraded Indonesia’s rating from a ‘speculative’ grade to investment grade. Moody’s move followed that of Fitch, which upgraded the country in December 2012.

With an enviable GDP growth rate of around 6%, Indonesia is attracting interest from MNCs and increasing levels of foreign direct investment (FDI). At the start of the year Indonesia’s Investment Co-ordinating Board (BKPM) reported record levels of FDI for the country. In 2012 IDR206 trillion ($20 billion) in foreign funds flowed into the country and the BKPM predicts a total of IDR270 trillion ($27 billion) will be invested in 2013.

FDI accounts for around 70% of the total direct investments in the country of IDR376 trillion ($38 billion). The BKPM oversees investments, granting business permits to overseas and domestic companies. During the past month the BKPM has received 400 requests for permits per day, compared to the usual 150.

Corporate attraction

The chairman of the BKPM, M. Chatib Basri, told a press conference that prevailing global economic uncertainties were benefitting Indonesia, as the situation causes investors to turn to emerging economies. “Brazil is growing by only 0.6%, India has problems with inflation and China is slowing down. If you were an investor looking to invest in emerging economies, where else to invest but here?” he told the Jakarta Post.

The mining sector accounts for the largest share of FDI at 17.3%. Observers believe this will increase as the government’s commitment not to export raw minerals, but to add value via mineral processing, bears fruit.

There have been some high profile investments in Indonesia during the past six months. French cosmetics giant L’Oréal has opened its largest factory globally at the Jababeka Industrial Estate in West Java. A phased investment of €100m will establish the factory as a production hub for South-East Asia. The company said the factory is a response to increased market demand in Indonesia and the Association of South-East Asian Nations (ASEAN) countries; 30% of production will be for the domestic market, with the remainder destined for South-East Asia.

Toyota also has invested in a new production facility in West Java via Toyota Motor Manufacturing Indonesia, a majority owned venture with local distributor PT Astra International. The plant has an initial output capacity of 70,000 units per year produced by 1100 workers.

These moves indicate that the interest in Indonesia is not based solely on natural resources; the country has another important resource – people. It is the fourth most populous country in the world with more than 250 million people, many of whom are young. In fact, 42.2% of the population is aged between 25 and 54 years. One quarter of the population is under 14 years old. More Indonesians are moving into the middle classes and consumerism is on the increase.

Domestic purchasing power

In a quarterly report published in April, global consultancy McKinsey says 90 million Indonesians will join the ‘consumer class’ by 2030 – more than in any emerging country apart from China and India. McKinsey estimates that this migration into the middle class will be worth an additional $1 trillion in annual spending. “Already, Indonesia’s consumer spending, at 61% of GDP (2010), is closer to levels in developed economies than to the corresponding figures for neighbouring, largely export-driven nations such as Malaysia and Thailand,” states the report.

“As the percentage of the country’s population living in urban areas grows from roughly 53% of Indonesia’s residents today to 71% in 2030, spending should grow in categories such as financial services, leisure, travel, and apparel.” This spending already has begun to grow among the country’s city dwellers.

“Indonesia always has been seen as a market with a lot of potential, although it only started fulfilling its potential in the past five years,” says ANZ’s Dyer. This change came, he adds, when Indonesia became a major country of interest for investors and MNCs as a production base, as well as a consumer base. This has been fuelled by the commodities boom and also regular GDP growth rates of 6-7%.

“You could term what we are seeing as a second renaissance of investment in Indonesia,” says Manfred Schmoelz, Head of Transaction Services, Asia Pacific at The Royal Bank of Scotland (RBS). “When China and India were closed to international investment during the 1980s and early 1990s, multinationals made substantial investments in Indonesia. Once India and China opened up, some of that investment flow was diverted. But with a more politically stable environment, Indonesia’s economy is growing and currency and interest rate regimes have improved. Therefore, investment is picking up again.”

Riko Tasmaya, Treasury and Trade Services Head in Indonesia for Citi, says the country is well positioned to attract FDI as 60% of the economy is driven by domestic demand. “Growing consumer purchasing power is the engine of the 6.2% GDP growth in the country. Among the emerging and growth economies, Indonesia accounts for 39% of combined GDP growth; this is predicted to rise to 58% by 2025. By then, we believe Indonesia will be one of the top ten world economies.”

Indonesia is the strongest of the ASEAN countries and plays a critical role in supporting the overall economic growth of that group, says Tasmaya. “Much of the growth in Indonesia is due to the high proportion of young people in the country and their high levels of productivity.”

All of these points, he says, make Indonesia a very attractive country for FDI; the majority of investment is coming from Singapore, South Korea, Japan and the US. “These investors will find tremendous opportunities related to natural resources, consumer purchasing powers and a growing manufacturing base as the government tries to encourage the growth of more value-added exports,” says Tasmaya.

Challenges

McKinsey’s quarterly points out that Indonesia’s consumer market is very complex, scattered over more than 17,000 islands where tastes and preferences vary. Indonesia’s distribution infrastructure is fragmented geographically and small retail stores predominate in many consumer categories.

This presents challenges for corporates, particularly when it comes to collections.

Tasmaya explains: “While Indonesia spans a vast area and is comprised of thousands of islands, less than 50% of the population is bankable. For this reason, cash use is very high and collections are a key challenge for corporates. Solutions need to offer timely and secure collections with automatic reconciliation capabilities. Global banks such as Citi are investing heavily in the technology to support such capabilities.” Many corporates are partnering with global banks that can provide an end-to-end proposition that covers integrated collections, advanced liquidity management and payments support on one technology platform, he says.

Schmoelz also cites Indonesia’s geography as a challenge for corporates looking to expand operations in the country. “One of the key issues in Indonesia is its geography; the country is made up of 17,000 islands that are spread across a distance the size of Europe. A great deal of infrastructure investment – in roads, rail and ports – is required to help move resources around.”

The Indonesian government is encouraging infrastructure development. In May 2011, the government announced its ‘Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development’, a long-term, nationwide development plan running up to 2025, which could be worth up to IDR4000 trillion ($402 billion). Of this total, 70% is expected to be financed by the private sector including state-owned enterprises (SOEs) and a public-private partnership (PPP) scheme.

In the past few years, the government eased regulations to make the infrastructure sector more investor-friendly, such as amending the law on PPPs and passing a new Land Acquisition Law, which allows the government to obtain civilian land for public works projects. The World Bank’s International Finance Corporation (IFC) reports that the Indonesian government’s infrastructure plans include constructing power plants that will supply 20,000 megawatts of electricity during the next decade and 1095 kilometres of new toll roads to move goods faster across the vast archipelago. The IFC estimates the cost of these investments as $150 billion during the next five years. However, the government can finance only 30% of the cost; the rest will come from the private sector.

Among recent infrastructure deals is a $4.8 billion investment by China Railway Group, won in March 2010, to build and operate a coal railway. The Financial Times reports that Indonesia is the world’s largest exporter of thermal coal, 15% of which goes to China. More recent projects include the construction of a $5.2 billion integrated railway network in Sulawesi; the construction of a monorail system for Jakarta; and the expansion of a terminal at Soekamo-Hatta International Airport. The government has introduced a nationwide freight transport programme to improve the movement of goods through the country’s vast waterways. As part of this programme, PT Pelabuhan Indonesia, the state-owned sea terminal operator, will construct Lamong Bay Terminal in Surabaya, East Java, with a planned inauguration in 2014.

In addition to a lack of physical infrastructure, Tasmaya says other challenges in Indonesia arise due to bureaucracy and corruption. “Good progress has been made on all of these fronts, although some concerns remain for investors, one of them with regard to labour reforms,” he says. “The government is on track to ensure that it doesn’t miss out on what it sees as a golden age in terms of its young population. Alongside investments in infrastructure and manufacturing, the government is investing in human capital, ensuring education is of a high enough quality to support economic growth. Attention also has been paid to innovation, with increases in the government R&D budget.”

At the same Reuters event earlier this year, President Yudhoyono conceded that corruption was more difficult to eradicate than he had thought, but he denied suggestions that it had risen in his eight and a half years in office. “It’s not getting any worse, it’s actually improving – but I am still not satisfied. I am frustrated, I am angry and I am annoyed,” he said.

Widespread perceptions of corruption and broad regional disparities in health point to ongoing challenges for policymakers seeking sustainable, broad-based prosperity, according to a Gallup study of Indonesia. Published in May, the report, ‘Indonesia’s Economic Emergence’, found that 88% of Indonesians thought corruption was widespread in public sector, with 82% believing it is also widespread in business.

Gallup points out that systemic corruption is considered by economists as a hindrance to economic development. One of the most common forms, bribery of government officials, raises average transaction costs and tends to hurt the poor, who are typically less able to pay and less likely to have political connections on which to draw. “The result is that deeply entrenched patterns of income inequality become even more difficult to overcome,” says the report. “This is another of Indonesia’s major challenges to broad-based economic development.” At present the household income of the country’s richest 20% of people is four times that of the average income of the remaining 80%.

Gallup’s report concludes that recent trends in Indonesia, including the improving economic outlook and rising satisfaction with healthcare and education among its people, suggest the country is improving its competitive position by empowering more of its citizens to drive economic development. However, it warns that ongoing corruption and extreme income inequality continue to undermine Indonesia’s economic potential by increasing the risks for investors, foreign and domestic.

Banking developments

For the time being at least, Indonesia is proving attractive to a large number of MNCs. The needs for these multinationals entering Indonesia, says Vinod Madhavan, Global Head, Local Corporate Products and Receivables and Supply Chain Finance (SCF) at Standard Chartered Bank, are the same as for those entering any emerging economy. “Companies are looking for cash management and working capital solutions. They require support from financial institutions that can understand their needs, have a strong local presence and therefore understanding of the market,” he says.

Indonesia is one of the more mature markets in the region when it comes to accounts receivable (AR)/accounts payable (AP) management, he says. “There is a wide network of ATMs under the banner of ATM Bersama, which are interlinked between most banks. Corporates can manage their consumer-to-business (C2B) receivables (such as utility payments) through the ATM network, as there is a capacity for consumers to pay bills via ATMs. This has eased some of the problems with collections in such a widespread country.” Collections efficiency and AR reconciliation are real “pain points” for corporates, he adds.

There are four main pillars to RBS’s work in Indonesia, says Rob Carmichael, Head of MNC Coverage, Indonesia, RBS. “These pillars are trade, cash, debt and hedging. One of the landmark transactions we did this year was to help arrange Indonesia and South-East Asia’s largest bond transaction for PT Pertamina, one of the world’s largest producers and exporters of liquefied natural gas (LNG).”

The PT Pertamina deal raised $3.25 billion in a US dollar-denominated bond sale. Conducted in May this year, it was the most valuable bond issuance from Indonesia to date, highlighting a growing trend of local Indonesian corporations tapping into the bond market. Pertamina received overwhelming interest for international investors, with offerings over-subscribing the initial target by 4.4 times. A total of $14.4 billion in orders from 667 international investors was booked. The offering was divided into two tranches with ten-year and 30-year tenors. Pertamina appointed Barclays Capital, RBS and Citigroup as the lead arrangers, with Bahana Securities, Danareksa Sekuritas and Mandiri Sekuritas acting as co-managers.

Carmichael says RBS also works with MNCs on currency hedging, and gives advice on how to repatriate dividend payments. SCF is a growing area; but whereas in Europe it can be focused on helping suppliers in financial difficulties, in Indonesia it is more to do with driving working capital efficiency, he says.

ANZ’s Dyer says the significant commodities exports from Indonesia generate interesting opportunities for structured trade finance and short-term trade products. “Our clients are looking to mitigate buyer risk and also be able to provide funding against stock and production assets, particularly in the case of palm oil.”

Standard Chartered is “very bullish”, says Madhavan, on trade innovations such as the Bank Payment Obligation (BPO). An alternative means of settlement in international trade, the BPO provides the benefits of a letter of credit (LC) in an automated environment. Importantly for banks, it offers the possibility of intermediation earlier in the supply chain by offering risk mitigation and financing services.

A BPO is an irrevocable undertaking given by one bank to another bank that payment will be made on a specified date after a specified event (such as delivery of goods) has taken place. The specified event is evidenced by a match report that is generated by SWIFT’s Trade Services Utility (TSU) or any equivalent transaction matching application.

The International Chamber of Commerce (ICC) cites a number of BPO benefits including:

  • Mitigating risks in international trade for buyers and sellers.

  • Speed, reliability and convenience.

  • Reduced costs and improved accuracy.

  • Improved risk management.

  • Assurance of payment.

  • Access to flexible financing options.

  • Securing the supply chain.

“The BPO delivers operational efficiency to corporates while also mitigating payments risk,” says Madhavan. “We are seeing a good interest in this instrument in Asia. There is a regulatory mandate in Indonesia that requires the use of LCs with commodity transactions and we think the industry will take up the BPO to meet these requirements and to improve operational efficiency at the same time.”

Regional influence

While multinationals are entering the Indonesian market, there is a growing trend for Indonesian companies to “step out into the wider region”, says Madhavan. “Indonesia plays an important role in ASEAN, given the size of its market and also its proximity to Singapore and to Australia.”

The ASEAN was formed in 1967 by Indonesia, Malaysia, the Philippines, Singapore and Thailand to promote political and economic co-operation and regional stability. Brunei joined in 1984, Vietnam in 1995, Laos and Myanmar in 1997 and Cambodia was the most recent addition in 1999. Indonesia’s GDP is almost double that of its closest competitor in ASEAN, Thailand.

Says Madhavan: “Domestic Indonesian companies are moving out into the region via Singapore; like the multinationals, they are looking for financial institutions that have a strong presence in the markets in which they are expanding. For example, there is strong export growth between Indonesia and Africa. Standard Chartered has a strong presence in Asia, Middle East and Africa, and can see many of these flows and help both sides of transactions.”

Dyer says Indonesia is a relatively open market for cash. Multinationals can sweep dollars offshore, although they cannot put local currency funds into cash pooling systems. “Given Indonesia’s relatively high interest rates, there is a lot of interest in domestic cash concentration. Many MNCs are happy to use their profits to invest locally because Indonesia is still very much in growth mode.”

There are some challenges, he adds, as the rupiah is a volatile currency and foreign currency reserves are relatively low versus some other Asian markets. “The taxation system is also perceived by many multinationals to be a high burden,” he says.

Many MNCs entering the Indonesian market have set up shared service centres (SSCs) in Singapore, for example, says Citi’s Tasmaya. According to the ‘Asia Pacific Treasury Management Barometer 2013’, a study carried out by Bank of America Merrill Lynch (BofA Merrill) and SunGard, 72% of corporates in the region have set up a regional treasury or SSC, the majority of them in Singapore. Of the treasurers surveyed in Indonesia, 52% said cash concentration will be a key focus during the next 12 months and 70% will be focusing on cash visibility as well.

“The depth and diversity of the Asia Pacific market has long served as both an opportunity and challenge for treasury professionals with regional responsibilities,” Paul Simpson, Global Head of Global Transaction Services (GTS) at Bank of America Merrill Lynch, stated in the report.

“On one hand, Hong Kong and Singapore have developed as hubs that are highly supportive of centralised operations and complex treasury structures. On the other, the region’s emerging markets, characterised by regulatory change, currency restrictions and systemic risks, provide a constant change to adapt to and leverage. Nowhere else in the world does a treasurer need to manage this level of contrast than in Asia Pacific.”

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