Published by: Bank Indonesia Jl. MH Thamrin No.

2, Jakarta Indonesia

The

Financial Stability Review (FSR) is one of the avenues through which

Bank Indonesia achieves its mission ≈to safeguard the stability of the Indonesian Rupiah by maintaining monetary and financial system stability towards sustainable economic growth.Δ FSR is published bi-annually with the objectives: To analyze potential risks confronting domestic financial system; To recommend policies to relevant authorities for promoting a stable financial system; and To foster market discipline and public knowledge on domestic and global financial system stability issues.

This edition was launched in September 2006 and is based on data and information available by the end of June 2006, except stated otherwise. With the exception of those stated in graphs and tables, all data sources are from Bank Indonesia. The pdf format is downloadable at http://www.bi.go.id Any inquiries, comments and feedback please contact : Bank Indonesia Directorate of Banking Research and Regulation Financial System Stability Bureau Jl.MH Thamrin No.2, Jakarta, Indonesia Phone : (+62-21) 381 7353, 8336 Fax : (+62-21) 2311672 E-mail : BSSK@bi.go.id

Financial Stability Review I - 2006
( No. 7, September 2006 )

ii

Table of Contents

Foreword Chapter 1 Overview Sources of Potential Instability The Impact of Potential Instability on the Financial System Measures to Mitigate Instability Risk Prospect of Financial System Stability Chapter 2 Macroeconomy International Economy Domestic Economy

vi 3 4 6 7 9 13 13 15

Equity Market Performance Mutual Funds Performance of Mutual Funds Bonds Market Government Bonds Corporate Bonds Box 4.1. Impacts of the Earthquake in Yogyakarta on Financial Stability Box 4.2. The Threat of Hot Mudflow in PorongSidoarjo on Financial Stability Box 4.3. The Impact of Limited Insurance Scheme Implementation

53 55 56 57 57 58

38 40 44 49

Chapter 3 Corporate and Household Sector Credit Risk in the Corporate Sector Credit Risk in the Household Sector

23 23 25

Box 4.4. Credit Information Bureau and Debtor Information System

Chapter 5 Financial Infrastructure Chapter 4 Financial Sector Banking Intermediary Function Credit Risk Provisions Liquidity Risk Market Risk Profitability Capital Non Bank Financial Institution Multi-finance Companies Business Volume Source of Funds Profitability and Solvency Capital Market Equity Market 31 31 32 34 42 42 45 46 47 50 50 50 51 52 52 52 Glossary, Abbreviation, Appendix Article Article 1 Hedge Fund Activities in Developing Countries and Effort of Maintain Financial Stability Article 2 The Efficiency of Indonesian Foreign Exchange Market Payment System Development of Payment System RTGS and Clearing Card-Based Payments Payment System Development

59 59 59 60 61

Box 5.1. 10% Minimum Payment For Credit Cards 62

3a 13a 27a

iii

List Graphs and Tables
Table
1.1. 2.1. 2.2. 2.3. 2.4. 4.1. 4.2. 4.3. 4.4. Financial Soundness Indicators Global Economic Indicators Policy Package Growth of Gross Domestic Product Balance of Payment Assumptions and Scenarios CAR - BI Rate Increased Scenario CAR - BI Rate Declined Scenario CAR - IDR Depreciation Scenario 3 14 16 17 19 45 46 46 46 3.1. 3.2. 38 39 45 3.3. 3.4. 3.5. 3.6. 3.7. 3.8. 3.9. 3.10. 3.11. 3.12. 3.13. 3.14. Amount and NPL of Working Capital & Investment Loan Tables in Boxes : 4.1.1. DIY Banking Statistic ( April 2006 ) 4.1.2. Bank Loans and Deposits in Yogyakarta ( April 2006 ) 4.2.1. Account Distribution Corporate Financial Indicator Corporate Loss Ratio Growth of ROA and ROE Cash Flow Corporate Leverage Business Survey Plan of Investment Consumer Loan & NPL Residential Inflation Lay-off Mortgages (House & Apartment) Consumer Confidence Index Consumer Expectation for the Next 6 Months 23 24 24 24 24 25 25 25 26 26 26 26 27 27

Graphs
2.1. 2.2. 2.3. 2.4. 2.5. 2.6. 2.7. 2.8. 2.9. World Commodities Price Trend of Global Interest Rate Trend of Regional & Global Index Trend of PE Ratio Capacity Utilization and Retail Sales Inflation, BI Rate and SBI Exchange Rate IDR to US $ Country Risk of Indonesia Expected Inflation for the Next 6 Months 14 14 15 15 16 17 18 19 20

iv

4.1. 4.2. 4.3. 4.4. 4.5. 4.6. 4.7. 4.8. 4.9. 4.10. 4.11. 4.12. 4.13. 4.14. 4.15. 4.16. 4.17. 4.18. 4.19. 4.20. 4.21. 4.22. 4.23. 4.24. 4.25. 4.26. 4.27. 4.28. 4.29. 4.30. 4.31. 4.32.

Credit growth, Deposit, and LDR Sectoral Credit Growth Growth of Property Loans Type of Credit Credit Growth per Type Growth of Loans to SMEs Gross NPL Net NPL Non Performing Loans Non Performing Loans - Foreign Currency & Rupiah Denomination Non Performing Loans - per Business Sector NPL of Trading and Manufacturing NPL - Industry Manufacturing Growth of NPL as of type Gross NPL of SMES Gross NPL Loans, NPL and Provision Liquidity Ratio Deposits Deposit Structure Deposits Structure - Per Ownership Deposit Structure - Per Nominal Amount Deposit - Lending Rate Spread NII and Certificate of Bank Indonesia Rate Cost Efficiency Ratio and ROA Komposisi Pendapatan Bunga Revenue Structure of 15 Large Banks Capital Adeguay Ratio Tier 1 to Risk Weighted Asset (June 2006) CAR as of Bank Peer Financial Structure of Multifinance Companies Securities and Loan Loss Provisions

31 32 32 33 33 34 34 34 35 35 35 35 36 36 36 37 42 42 43 43 43 43 46 46 47 47 47 48 48 48 50 51

4.33. 4.34. 4.35. 4.36. 4.37. 4.38. 4.39. 4.40. 4.41. 4.42. 4.43. 4.44. 4.45. 4.46. 4.47. 4.48. 4.49. 4.50. 4.51. 5.1. 5.2. 5.3. 5.4. 5.5.

Source of Funds Funding Structure Debt/Assets, and Debt/Financing Ratios Capital/Financing Foreign Investors Transactions Volatility of JCI JCI and Market Capitalization Foreign Investors Trading Sectoral Index and JCI Mutual Fund and Net Asset Values Type of Mutual Funds Bond Prices - Selected Series Yield Spread of Selected Asian Countries Government Securities Yield Curve Ownership of Government Bond Corporate Bond Corporate Bond Holders Issuer Profile RTGS Settlements RTGS Players Clearing Settlements Value of ATM, Credit and Debit Cards Transactions Volume of ATM, Credit and Debit Cards Transactions

51 51 52 52 53 54 54 54 55 56 56 57 57 58 58 58 58 59 59 60 60 60 61

Jakarta Composite Index and Volume of Shares 53

Graphs in Boxes : 4.1.1. Sectoral Credit - DIY 4.1.2. Type of Credit - DIY 4.2.1 Deposits 38 38 45

v

Foreword

Financial system stability is prerequisite to a sustainable economy and, hence, surveillance to monitor potential risks that threaten financial system stability is a necessity. The Financial Stability Review (FSR) is a venue through which Bank Indonesia continually monitors and analyzes all potential factors that may incite financial instability. This publication is expected to deliver comprehensive information to all stakeholders in the financial system and, consequently, relationships among the agents in the financial system, potential threats, as well as anticipative measures can be well-understood. The FSR also represents a means to disseminate pertinent information concerning the role and responsibility of Bank Indonesia in safeguarding the stability of the domestic financial system. During the course of the reporting period, domestic financial system stability remained in a positive shape. The financial system has shown resilience in absorbing externalities stemming from persistent global imbalances, an incessantly soaring global oil price, and the global trend of interest rate hikes. The Fed Fund Rate and international capital flows have been two major drivers determining indices in domestic capital markets. In addition, vulnerability in the domestic equity markets has become increasingly correlated to movements in the equity market of other emerging markets. Identical equity market rallies in the vast majority of emerging countries, including Indonesia, have been occasionally suspended by the rise of the Fed Fund Rate that was previously expected to have peaked. This has illustrated the increasingly integrated financial markets as a result of globalization and, therefore, regional effects have been more crystallized. The second round effect of last year»s fuel price hikes generated detrimental impacts on the purchasing power of the household sector. Significant spill-over effects have impinged on domestic economic growth and the intermediary role of banks. Loan growth and business activities decelerated despite intermediation from bond issuance remaining steady, a condition reflecting that the role of the financial system in generating financing remained sub-optimal. On the other hand, capital markets recorded pleasing intermediary performance as reflected by substantial growth in the number of Initial Public Offerings (IPO), a condition indicating the burgeoning intermediary role of the non-banking sector. Downward pressure on purchasing power coupled with rising living costs slashed consumer demand and, therefore, production has decelerated. This was exacerbated by the high production costs and sub-optimal business environment. These conditions have diminished the repayment capacity of both producers and consumers and, hence, triggered upward credit risk pressures in the financial system. This has been reflected by the increase in the impaired asset ratio, which surpassed the indicative threshold of 5%, net of provision. In addition, the asset quality of non-bank financial institutions deteriorated, particularly credit card financing. This adverse state of affairs requires banks and other financial institutions to enhance their capabilities in handling problem financing and loans intensively. To this end, capacity enhancement in the areas of risk management and risk measurement for all financial institutions has been the focal point in endeavors to

vi

safeguard financial system stability. Through risk-management certification, it is expected that bankers will have more capacity to manage and measure risks and, hence, risks can be well-mitigated and handled. Besides, the launch of the Credit Bureau is expected to enhance disclosure and helps banks avoid adverse selection. These measures help build a sounder banking system capable of carrying out its functions effectively. Even though the intermediary function decelerated, financial institutions maintained steady profitability and solvency. Banks and finance companies reported positive profits leading to a positive accumulation of capital, a condition reflecting steady domestic financial stability despite recent externalities. Furthermore, measures to mitigate risks have been introduced by Bank Indonesia, the government and the corporate sector in order to maintain sustainable economy growth. The government instituted a policy package to improve the investment climate and upgrade existing infrastructure. Bank Indonesia and the government made concerted efforts to launch a financial sector policy package in an endeavor to safeguard domestic financial system stability. Furthermore, corporations have had to continuously improve efficiency to survive in the changing business environment via organizational restructuring, innovation, market expansion as well as developing alternative sources of energy. The outlook appears to be positive. Near-term financial stability is more optimistic, which is attributable to rising intermediation and the robust payment system. The recovery of macro-economy indicators, particularly inflation expectations, exchange rates, the balance of payment, sovereign rating, as well as positive expectations on returns in domestic financial markets will help stimulate economy growth and stabilize the financial system. Nevertheless, challenges remain. Growth in intermediation is predicted to remain at an average level considering the lagged response of domestic lending rates to the easing of monetary policy and the recent decline of the Bank Indonesia Rate. Finally, we wish this publication furnishes stakeholders with comprehensive information concerning potential risks and recent financial system conditions. Therefore, it is expected that efforts to safeguard financial system stability can be concerted corresponding to the roles of the relevant authorities. Bank Indonesia also expresses gratitude to bankers, finance companies, security companies, authorities of capital markets, and all self-regulatory organizations involved, whose significant contributions have enriched this edition. Constructive commentaries from stakeholders are urgently sought to help Bank Indonesia enhance the surveillance and upcoming review. May Allah Almighty bestow His blessing on our good intentions and deeds.

Jakarta, September 2006 Deputy Governor

Maman H. Somantri

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Chapter I Overview

Chapter 1 Overview

1

Chapter I Overview

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2

Chapter I Overview

Chapter 1 Overview
Amidst risk pressures resulting from the second-round effects of the last year»s oil prices and an upswing in interest rates, financial system stability in Indonesia remained positive. The near-term outlook is optimistic, as financial system stability in Indonesia is forecast to improve in line with the increasingly recovering domestic economy.
Table1.1 Financial Soundness Indicators
Main Indicator
Banking Growth of Credit (yoy-%) Growth of Deposits (yoy-%) LDR (%) ROA (%) NPL gross (%) NPL net (%) NIM (%) ER (%) CAR (%) Multi-Finance Growth of Financing (yoy-%) Debt - Financing Ratio CAR (%) Stock Market JCI (Jakarta Composite Index) Capitalization (Billions of Rp) Foreign Transaction (Billions of Rp) Bond Market IGSYC 3 year (%) Volume of Government Bond (Trillions of Rp) Volume of Corporate Bond (Trillions of Rp) Mutual Fund Net Asset Value (Trillions of Rp) Fixed Income (Trillions of Rp) Equity (Trillions of Rp) Corporation ROA (%) DER EBT (Billion of Rp) Forecast of Business Forecast of Sale Price Forecast of Employment Business Situation Expectation of Business Situation in 6 Month forward Expectation of Retail Price in 6 Month Forward Household Current Economic Condition Consumer Expectation Consumer Confidence Index
* Data as of quarter-I 2006

2004 I
21.93 7.96 57.92 2.67 7.55 2.10 0.49 86.99 20.93 45.24 1.02 16.05 732.40 495.798 107.82 NA 32.81 0.98 84.71 71.02 0.71 4.53 1.47 135.31 10.06 10.85 4.23 24.88 34.12 123.3 74.52 110.23 92.38

2005 II
27.03 9.30 61.79 3.46 5.75 1.72 0.55 76.64 19.37 33.85 1.08 13.99 1000.23 679.949 2,147.23 9,15 48.04 1.79 100.98 85.04 1.89 9.82 1.19 375.56 20.25 12.06 0.00 33.65 43.27 119.2 101.8 136.3 119.1

2006 II I
24.34 16.86 64.73 2.64 8.30 4.82 0.48 88.32 19.47 33.85 1.09 12.30 1162.64 801.253 1,283.95 13,22 7.55 4.5 28.39 12.97 4.93 10.01 1.08 262.43 14.17 44.76 5.11 16.30 31.46 119.8 71.94 101.24 86.59 14.01 15.55 64.83 2.54 8.75 5.08 0.54 83.23 20.46 21.33 1.07 13.96 1310.26 901.021 (605.30) 12,33 5.32 0.93 33.06 13.26 4.71 4.15 * 0.87 * 130.82* 22.25 15.78 5.16 17.76 36.77 139.2 76.80 105.40 91.10

I
27.98 11.85 65.71 2.91 7.92 3.66 0.49 87.20 19.45 21.33 1.07 12.99 1122.37 765.811 2,344.02 10,44 39.84 0.97 80.17 55.14 5.03 7.11 0.99 216.57 28.27 28.80 8.90 23.80 39.09 137 87.19 116.22 101.70

3

Chapter I Overview

SOURCES OF POTENTIAL INSTABILITY
Financial system stability is a result of interactions amongst all components of an economy strongly influenced by domestic and international factors. Continual vulnerability in the international economy had a strong impact on the stability of the domestic financial system during the course of semester I. Sources of the recent susceptibility included international oil price fluctuations, the persistence of global imbalances, and the rising global interest rate. Besides, upward risk pressures, as a result of geopolitical tension and the stronger regional effect on domestic economy, triggered potential instability in the financial system.

The supply and demand gap has been the root of the persistently high global oil priceº
Despite the rapid growth in global oil consumption decelerating, persistently high demand coupled with short supply put upward pressure on the global oil price, which recently showed higher volatility. This was also spurred by geopolitical tension in Iran and Iraq and disturbances in oil production in Nigeria. Volatility in the oil price is likely to be more relentless than that of the oil price crisis in the 1970»s. Escalation of the Middle East crisis and the persistently wide supply-demand gap in international markets will drastically amplify oil price expectations; forecast to reach USD100 per barrel.

º and triggered global interest rates hikesº
The persistently high oil price in international markets placed growing pressures on global inflation which has tended to rise. This has driven tight-biased monetary policies in the vast majority of world economies, which are expected to persist for the next couple of years. The expectation of a continuous cycle of a spiraling Fed Fund Rate triggered more capital inflows to the United States. Nevertheless, the existing positive expectations of investment returns in Indonesia helped mitigate the risk of capital outflows from the country.

Global interest rates determined international capital movement, which has been prone to generate greater and deeper regional effectsº.
The search for yield by hedge funds drove greater capital inflows into emerging countries. This was attributable to optimistic expectations on the returns of investment in these countries as a result of attractive interest rates and economic growth. Notwithstanding, this condition made emerging countries more susceptible to regional effects, as depicted by simultaneous and identical bullish rallies in these countries» capital markets. Indonesian capital markets have also been the target of international capital flows. Capital inflows to domestic capital markets dramatically drove short-lived bullish rallies in the equity market and more active transactions in the bond market. The potential risk of an equity market bubble finally came to an end following the continuation of raising Fed Fund Rate. As a result, the bond market, particularly government bonds, experienced active rallies resulting from inflows of foreign investors, a condition which helped to recover the domestic bond market.

4

Chapter I Overview

ºmarket risk exposure, nevertheless, remained solubleº
Appealing domestic interest rates and expected returns in the Indonesian capital markets attracted more capital inflows. This spawned bullish asset prices and exchange rate appreciation. Notwithstanding, banks had the capacity to mitigate price risk because they held sufficient capital and their asset structures were predominantly in the form of government securities held to maturity (SUN) and Bank Indonesia certificates (SBI). Additionally, the net open position of banks was far less than the mandatory threshold; another mitigating tool to insulate banks from unexpected losses emanating from foreign exchange risk.

Weaker purchasing power did not contribute to economy growth and, therefore, created unfavorable impacts on intermediation growthº
The second-round effects of fuel price hikes in the third quarter of 2005 had latent ramifications on household purchasing power. As a result, the economy slowed slightly in the first quarter; rebounding in the second quarter of 2006. Lower purchasing power coupled with rising lending interest rates contributed to weaker intermediation by financial institutions in the first quarter. Compared to the previous semester, the credit growth of banks and multi-finance companies declined. However, financing from the equity markets grew significantly, while bond markets also showed positive growth. Notwithstanding, it appeared that the economy grow more rapidly than financial sector intermediation, a condition indicating the emergence of intermediation from the non-financial sector.

ºfollowed by slight upward risk pressures on credit in the first quarterº
Weaker purchasing power since October 2005 impinged on demand and, therefore, hampered production and the subsequent profitability of the corporate sector. This reduced the repayment capacity of all debtors leading to credit quality deterioration, particularly in the first quarter of 2006. Investment loans and credit cards were two segments which significantly contributed to the deterioration. Credit quality began to rebound in the second quarter, attributable to the steady recovery of corporate debtor profitability. In addition, the business confidence index has shown an improvement with a positive outlook since the beginning of the year. Moreover, the annual salary bonus given to civil servants helped improve the repayment capacity of household economies, thus stabilizing the profitability of financial institutions.

....nevertheless, the liquidity of banks remained in good shape despite the pressuresº
Despite the lower purchasing power, banks effectively maintained a secure level of liquidity position. This indicated that the level of customer savings was maintained attributable to attractive domestic interest rates for savings and time deposits. Conversely, perceived uncertainty surrounding business forced business players to postpone expansion whilst waiting for domestic interest rates to ease. This encouraged business players to retain their liquidity in time deposits as they expected an attractive pay off from the interest.

5

Chapter I Overview

The generally moderate risk exposure did not engender downward pressure on the profitability or capital of financial institutions.
The risk pressures did not threaten financial system stability. The profitability of banks and financial institutions remained steady and their efficiency continued to improve. This development did not impose continuous pressures on capital adequacy in the financial system. The relatively high CAR of banks indicated that the level of stability is relatively sufficient. Financial system stability is also supported by the robustness of the payment system, which has been equipped to encounter operational disruptions via the installation of a Disaster Recovery Center and, therefore, potential failures in the system can be sufficiently mitigated.

THE IMPACT OF POTENTIAL INSTABILITY ON THE FINANCIAL SYSTEM

Persistence of the soaring international oil price may threaten macroeconomic stabilityº
Potential sources of instability, as explained previously, may pose both direct and indirect upward risk pressures. The continuously rising oil price and the prediction it may reach USD100 per barrel may become potential sources of critical risks in the domestic financial system. Transmission of this risk pressure can occur through the probability of domestic fuel price re-adjustments. This development is determined by the capability of the state budget to absorb the oil price shock. Previous experience has shown that substantial fuel price increases create higher costs for the national economy compared to subsidy efficiency. However, government signals indicated that they will not raise domestic fuel prices up to the end of 2006; even if the oil price reaches USD 100 per barrel. This indicates that externalities will not trigger domestic upward risk pressures, at least until the end of this year.

ºand domestic financial system stability through transmission of corporate and household sectorº
If global oil price pressures are transmitted to domestic fuel prices, then this can create disturbances in the real economy (corporate and real economy) via the subsequent rise in production and living costs as well as higher unemployment. Such a development will further reduce repayment capacity and, therefore, bring prompt credit risk pressures leading to a deterioration in credit quality. The second-round effects could reduce the profitability and solvency of financial institutions.

ºhigh international inflation affected the movement of interest rates and international capital flowsº
Amid the prospect of a domestic interest rate decline, the narrowing interest rate differential between domestic and international rates appeared to be a disincentive for short-term capital inflows to financial markets. This may induce capital reversal risk, which can threaten the stability of foreign exchange and capital markets, in particular equity and bond markets can become distorted. Such distortions can raise market risk exposure for financial institutions.

6

Chapter I Overview

Weaker purchasing power, if persistent, can push domestic financial stability downº
The prevailing low purchasing power, if persistent, could undermine economic growth by disturbing production. This process will reduce corporate profitability and repayment capacity and, therefore, credit risks are likely to emerge. If no solution can be found, the financial system will be subjected to instability.

MEASURES TO MITIGATE INSTABILITY RISK
Against these challenges, the government and Bank Indonesia exercised proactive measures to safeguard financial system stability, including:

Bank Indonesia launched the January Policy Package
This parcel of policy measures is aimed at expediting the recovery of the intermediation process, thus providing a boost to the economic recovery. The policy package includes: asset quality rules, expansion of the provision of banking services to the Micro, Small and Medium Enterprises (MSME), adjustment of Risk-Weight Assets on mortgage and pensioner loans, and the implementation of good corporate governance (GCG).

Government launched the Investment Climate Policy Package
The objective of this policy package is to expedite the realization of investment to stimulate sustainable economy growth. This package comprises of improvement measures in the following areas: investment services, provincial and central government regulations harmonization, customs and taxation, employment relations, as well as improving the MSME and cooperative business environment. However, the implementation of these policy measures seems to remain suboptimal. Hence, strong commitment from the appropriate authorities is the key success factor in achieving a sustainable economy as well as financial system stability.

The government also launched the Infrastructure Policy Package
Through this policy package it is expected that infrastructure improvement supports growth in investment and production activities. The package details measures in the areas of regulatory and institutional frameworks, transportation, toll roads, electricity, public roads, gas and oil, water and sanitation, housing, provincial and transaction infrastructure project development.

Bank Indonesia and the government launched the Financial Sector Package
The objective of this coordinated policy package is to enhance the financial sector, in terms of financial system stability, to perform its intermediary role effectively and, therefore, support a sustainable economy. The policy package encompasses measures to bolster financial system stability, banking and non-banking financial institutions as well as capital markets.

7

Chapter I Overview

-

Strengthening financial system stability through the implementation of a Financial Safety Net (FSN) and coordination amongst the authorities responsible for safeguarding financial stability. FSN is designed as a contingency plan implemented by the government and Bank Indonesia to prevent systemic banking crisis;

-

Bolstering banking institutions via the implementation of good corporate governance and effective risk management, establishment of the Credit Bureau, enhancement of banking supervision and regulation, customer protection, and banking consolidation;

-

Augmenting non-bank financial institutions via structural improvements in the insurance industry, pension funds and multi-finance companies. Additionally, the capital markets are being strengthened by the merger of the Jakarta Stock Exchange and Surabaya Stock Exchange, the implementation of remote trading, development of secondary markets and products, development of government bonds and the mutual funds industry;

-

In particular, the policy package also stipulates the establishment of the Indonesian Export Financing Agency;

Bank Indonesia enhanced regulations to reduce credit risk pressure
Building capacity to mitigate and manage credit risk through: Establishment of the Credit Bureau; Capacity building for risk management via Risk Management Certification; Institute regulations to improve banking prudence, in the allocation of credit for instance, imposing a legal lending limit, provisioning, and asset quality assurance; Stimulate banks to restructure impaired assets; Encourage banks to be more prudential and selective when making unsecured loans, for example credit cards and uncollateralized loans; Raise the minimum payment for outstanding credit card debt to 10%; and Prepare for Basel II implementation focused on risk management.

Fiscal stimuli are needed to boost intermediation
In order to enhance the role of capital markets as one of the primary funding sources, it is imperative that taxation incentives for initial public offerings be considered. It is also important to establish more and fair transparent pricing in the secondary bond markets.

Measures to continuously enhance the payment system have always been implemented by Bank Indonesia
This, among others, is conducted via monitoring and regulating Card-Based Payment Means to protect card users and issuers, safeguard the operational preparedness of DRC (Disaster and Recovery Center) via regular back-testing, as well as preventing payment system disruption by implementing a Failure-to-Settle scheme. Nevertheless, active participation of all payment system members in regular DRC tests is crucial. Furthermore, to improve transparency, security and customer protection in electronic transactions and remittance, Bank Indonesia is currently drawing up regulations for electronic transactions.

8

Chapter I Overview

The role of the corporate sector to enhance efficiency
Corporations have implemented various efficiency measures as a means of survival by sourcing alternative energy (by building a power plant for example), downsizing and maximizing their utilization of capital goods as well as product innovation and market penetration to create profitable niche markets. Besides, the government must always encourage the corporate sector to continuously adhere to risk management and good corporate governance principles as well as ensure productive innovation to achieve competitive advantage in international and domestic markets.

Strong commitment of Bank Indonesia to maintain low inflation
Bank Indonesia recognizes that the sluggish real economy is the result of a high cost of funds. In order to maintain a low inflation equilibrium it is crucial to balance supply and demand. With falling inflation, the monetary authority is likely to relax monetary policy to support sustainable economy growth capable of maintaining low inflation. Therefore, interest rate formation can be lower and is able to dampen the costs of living and production; hence bringing about lower prices. To this end, Bank Indonesia consistently implements monetary policy to achieve low inflation.

Purchasing Power should be supported through a variety of efforts
Lower purchasing power deferred the flow of the economy. To help restore purchasing power, the government plans to raise civil servants salaries by 10%-15% in 2007. Nevertheless, this measure requires extreme caution to prevent excessive spikes in inflation expectations that may lead to macroeconomic distortion. Besides, the banking industry is expected to adjust the cost of funds for consumer loans commensurate to the significant cutbacks in the BI rate. This is expected to help boost demand for consumer loans and stimulate production. Fiscal stimuli are expected to play a stronger role via a relaxation in income tax and raising the Direct Cash Subsidy (DCS). The DCS is a subsidy scheme to the poorest of the poor with a focus on health, education and infrastructure. This scheme is a pilot project that will be implemented in several provinces in 2007 and is aimed to become a provincial social security program in 2008.

Initiatives to develop alternative sources of energy needs to be intensified
Against the persistently high oil price, Indonesia √as a net oil importer- continuously seeks alternative sources of energy. This includes the development of biodiesel and the use of coal in electricity production by the state electricity company. To this extent, financial institutions are encouraged to allocate financing to corporate debtors with a business line in this type of industry as its prospects are indeed promising.

PROSPECT OF FINANCIAL SYSTEM STABILITY
Stability of the Indonesian financial system in semester II 2006 appears to be more positive
Considering the risks that have potentially spurred near-term instability and the mitigating measures that have been implemented, financial system stability in semester II-2006 has been more optimistic. This is supported by a recovery in

9

Chapter I Overview

the macroeconomy reflected by declining inflation, rising GDP growth, improving balance of payments, more conducive fiscal conditions as well as exchange rate appreciation and falling interest rates. Corporate sector performance is predicted to improve considering the more conducive macro-economy, effective survival measures and corporate efficiency. This is expected to encourage optimistic expectations and better domestic financing and, therefore, the quality of financial system liquidity will be accurately allocated to the real economy. The ramifications of this positive development are expected to help raise the income and purchasing power of the household sector and, ultimately raise domestic consumption and production.

Financial system intermediation rebounds
The above-mentioned improvements are expected to develop the effectiveness of the banking intermediary function that was significantly undermined in the first semester of 2006. Insensitivity to loan interest rates is expected to ease along with the continual declining cycle of the BI rate. On the other hand, credit growth is predicted to rebound after slowing in semester I 2006. The improved banking intermediary function is expected to stimulate financing from multi-finance companies, as banking is their major sources of fund. This is expected to help accelerate economy growth in 2006, despite remaining sub-optimal considering the likely postponement of credit demand by debtors looking for further decline in interest rate.

Credit risk pressure in the financial system will dissipate
Economic improvements are expected to help restore the repayment capacity of the real sector both corporate and household and, therefore, credit risk in financial system is expected to dissipate. Non-performing loans in the financial system are expected to improve followed by a rise in the profitability and solvency of banks. Improving financial system stability is expected to help create a more solid financial system which can perform its intermediary role efficiently and effectively. The rapid recovery of financial system stability to levels seen before the crisis is expected to transpire and, therefore, facilitate economic resilience.

Bullish capital market is likely with prevailing foreign investment
Improvement in the sovereign rating for both international and domestic debts, referred to as Standard and Poor»s and Moody»s is expected to lift investor confidence in investing in Indonesia. An influx of short-term capital inflows is forecast to materialize with economic growth as the main determinant. Such a situation will predictably stimulate bullish rallies in the equity as well as domestic bond markets. Furthermore, positive business and economy conditions in the near-term are forecast to raise intermediation and financing through the equity and bond markets. This forecast is also supported by the positive expectations of business players and consumers towards production and consumption in the near-term. Furthermore, the bullishness of the bond markets, particularly government bonds, is also supported by the innovative retail government bonds, which have started to emerge as an alternative outlet for investment.

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Chapter 2 Macroeconomic Stability

Chapter 2 Macroeconomic Stability

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Chapter 2 Macroeconomic Stability

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Chapter 2 Macroeconomic Stability

Chapter 2

Macroeconomy

Macroeconomy remained stable despite second round effect of oil price hikes in 2005. International risks stemming from oil price, global imbalance and interest rate were subdued.

Prolonged externalities of oil price volatility, global imbalance and tight monetary policies, didi not substantially disrupt domestic economy stability. Yet, capital flows in capital market created slightly vulnerabilities as Fed Fund increased. Second round effect of oil price hikes led to a lower purchasing power and decelerated economic growth. Nevertheless, macroeconomic stability kept on, indicated by improvement in inflation, exchange rate, fiscal budget and balance of payment. Advancement in fiscal budget, predominantly triggered by IMF debt repayment, swap and hair cut. Furthermore, climbing international commodity price bolstered balance of payment.

consumption and investment. Albeit decelerating, growth in prominent emerging markets, particularly in China, India and Russia, remained sound. The US economy -as the primary driver of growth, both globally and in the industrial world- is forecast to strengthen growth. In the near-term outlook, the global economy appears to slowdown slightly given the persistently high oil price and rising interest rates. Global imbalances have stemmed from growing current account deficits in the US; nearing 6.5% of GDP, and the surpluses from oil exporting countries, China and Japan as well as some emerging countries. Current account deficits in the US were driven by high household

INTERNATIONAL ECONOMY
Risks pressures stemming from persevered global economy. It is forecast to intensify in the next semester.
Throughout the first half of 2006, the global economy continued to be driven by the soaring global oil price, persistent global imbalances and tightening monetary policy. Against this backdrop and despite natural disasters in some parts of the world, the forecast for global economic growth remained strong compared to 2005. Consumer and business confidence were forecast to continue improving with an upward trend in

consumption, underpinned by the wealth effect and the continuous rise in asset prices; predominantly property. The US did not confront problems in financing the deficits as the fund inflows have remained high. The persistence of global imbalance will possibly trigger instability given the imbalances in global financial flows. Corrective measures to purge the imbalances require adjustments to boost savings in the US, whilst expanding expenditure in the surplus economies. In addition, the exchange rates in the surplus countries have to be adjusted for appreciation. Such adjustments have begun in China and Malaysia; changing from previously pegging their currencies to the

13

Chapter 2 Macroeconomic Stability

Table 2.1 Global Economic Indicators
% 2004 World Output Advanced Economies Emerging & Developing Countries Consumer Price Advanced Economies Emerging & Developing Countries LIBOR US Dollar Deposit Euro Deposit Yen Deposit Oil Price (US$)
Source: World Economic Outlook

oil price is forecast to surpass USD100 per barrel unless the adverse geopolitical crisis is settled. The rising oil price
Projection 2006 4.9 3 6.9 2.3 5.4 5 3 0.3 14.8 2007 4.7 2.8 6.6 2.1 4.8 5.1 3.4 0.9 2.9

has been more driven by a scarcity in supply, despite the demand growth for oil declining. The decline in global oil consumption has been supported by a shift to alternative sources of energy such as bio-energy as well as more efficient consumption. The International Energy Agency

2005 4.8 2.7 7.2 2.3 5.4 3.8 2.2 0.1 41.3

5.3 3.3 7.6 2 5.7 1.8 2.1 0.1 30.7

estimates that both upstream and downstream investments in the oil industry remain short by about 20% of global demand. The future commodity markets predict that price and volatility of the global oil price will likely rise. Price volatility is considered likely to be more persistent than during the oil crisis in the 1970»s. The high-level persistence of the soaring global oil price and the price hikes of some international commodities have caused global inflation to remain high in 2006; forecast to reach the same level as 2005. Increasing upward inflationary pressure and current account deficits have driven central banks to exercise tight-biased monetary policy. Trends of global short-term interest rates will likely rise over the next two years driven by movements in the Fed Fund Rate. The Fed made four adjustments to its Fed Fund Rate in semester I-2006; by 100 bps, accumulating to 5.25%. The continual rise in the Fed Fund Rate will pose serious threats to capital movements in Indonesia.
Graph 2.2 Trend of Global Interest Rate
(%) 8

USD to becoming more flexible by pegging to a basket of currencies. In general, the oil exporting countries have high savings rates. The savings are invested in real estate and equity markets; as well as channeled through hedge funds in the Middle East and emerging economies. The oil price continued to soar and volatility reached its highest ever level. However the price rebounded to USD70 per barrel in May 2006. This was triggered by heightening geopolitical tension in the Middle East, obstruction of supply in Russia, and nuclear weapon trials by North Korea. Unless abated, these factors will lead to a continuous oil supply deficiency and intensified upward pressures as well as volatility. By the end of 2006, the global
Graph 2.1 World Commodities Price
US $ 500 450 400 350 300 250 200 150 100 50 0 2000
Source: Bloomberg

Oil Gold Aluminium Copper Tin

7 6 5 4 3 2 1

Fed Rund Rate LIBOR SIBOR

2001

2002

2003

2004

2005

2006

0 2000
Source: Bloomberg

2001

2002

2003

2005

2006

14

Chapter 2 Macroeconomic Stability

Graph 2.3 Trend of Regional & Global Index
DJIA, NKY 18,500 17,500 16,500 15,500 14,500 13,500 12,500 11,500 10,500 9,500 Jan
Source : Bloomberg

The regional equity markets in Southeast Asia reported bullish trends, particularly at the beginning of
7,000 6,000 5,000

IHSG, SET, STI, PCOMP & KLSE

the year as a result of capital inflows into emerging markets. Funds from the surplus countries surged through hedge funds. Notwithstanding, by the end of semester I2006, the regional equity markets in Asia had experienced a bearish trend as a result of a downfall in the Brazilian and Turkish equity markets following the rise in the Fed Fund Rate. Regional developments in global equity markets have had strong impacts with greater magnitude; indicating the increasingly integrated global financial

NKY STI IHSG SET Feb Mar 2006 Apr May Jun DJIA PCOMP KLSE

4,000 3,000 2,000 1,000 -

Global macroeconomic conditions have profound impacts on global capital markets. The indices of global markets were driven by expectations on the movement of global interest rates, prices of commodities, inflationary pressures and GDP growth. The movement of interest rates in major economies, particularly the Fed Fund Rate, attracted significant attention. Global investors previously expected that the trend of the Fed Fund Rate would be brought to an end, a condition encouraging euphoria in global equity markets at the beginning of the year. At this time in Japan, investors predicted that the ≈near zero interest rateΔ and deflationary period would end. Nevertheless, up to the end of semester I-2006, these expectations have not materialized. Investors have had to rethink their expectations, as the Fed Fund Rate has continued to rise.
Graph 2.4 Trend of PE Ratio
50 45 40 35 30 25 20 15 10 5 0
Source : Bloomberg NYA KLCI STI SET PCOMP

markets, which are prone to contagion effects. Political instability in some countries exacerbated their equity markets, yet did not trigger prolonged bearish conditions. Except for SET, all regional indices recorded upbeat trends. Thailand has suffered from political tension recently; however, its equity market remains attractive for investors given the relatively reasonable PER. PER for the other equity markets in the region remained practically identical. The outlook of global risk in the near term is still in the upward pressures in consequence of prolonged oil price rise, inflation nuisance and increasing interest rate. Accordingly, global economy growth is forecast to slow down, particularly in United States. High probability of housing bubble burst in US and in others, might lead to a deep shrink in global economy. Furthermore, this will restrain increasing cycle of Fed Fund which leads capital flows to the emerging market. Increasing geopolitical tension in middle-east could disrupt oil supply and threaten

SET NYA STI KLCI JCI PCOMP

world economy if oil prices are skyrocketing.

JCI

DOMESTIC ECONOMY
The domestic economy remained stable with lower instability pressures. However, the second-round effects of last year»s fuel price hikes placed

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun 2005 2006

downward pressures on domestic economic growth.

15

Chapter 2 Macroeconomic Stability

Despite the trend of currency appreciation and the postponement of basic electricity tariff increases, domestic economy growth declined compared to the previous year. Uncertainty surrounding any increase in the electricity tariff triggered high uncertainty in the business sector, undermining production. Furthermore, uncertainty surrounding exchange rates, in terms of both depreciation and appreciation, has added to uncertainty in the real economy in implementing business plans. A decline in household consumption and private investment forced cutbacks domestic economic growth. On the other hand, consumer purchasing power also declined as a result of

domestic fuel price hikes. This was reflected by a decrease in capacity utilization of machinery as well as retail sales

Graph 2.5 Capacity Utilization and Retail Sales
85 80 75 70 65 60 55 50 45 40 2003 2004 2005 2006 Capacity Utilization Retail Sales 160 140 120 100 80 60 200 180

Table 2.2 Policy Package
Investment Climate I. General a. Strenghten the institution of investment service b. Harmonize the central and province regulation c. Clarification of regulations in environment compliance II. Tax and tariff a. Accelerate the flows of goods. b. Develop bounded zone c. Abolish smuggling. d. Tariff simplicity. III. Taxes a. tax incentive for investment b. ≈self assessmentΔ implementation c. change value added tax in export d. protect the rights of tax obligor e. promote of transparency and disclosure IV. Labor Force a. Create an industrial climate which support employment. b. Protection and placement of Indonesian labor abroad. c. Resolution in industrial environment. d. Accelerate labor license. e. Create a flexible and productive labor market. f. Create a breakthrough of a transmigration development. V. Develop of micro, small and medium scale enterprises. Infrastructure I. Policy, regulation and institution framework II. Sectoral Policy - land transportation - train - marine transportation - air transportation - toll road and road - powerplant - oil and gas - post and telecommunication - drinking water, sanitation, and water resource - residential III. Regional Governance IV. Transaction of infrastructure development project Financial sector I. Financial System Stability a. Bolster financial sector coordination b. Forum of financial system stability II. Banking Financial Institution a. Strengthen banking institution - Human resource development - Implementation of Good Corporate Governance - Increase the quality of credit bureau - Increase the efficiency and effectivity of supervision - Consumer and investor protection - Improvement of market institution and structure b. Improve the performance of State Owned Banks - Non performing loan resolution III. Non bank financial institution a. Know Your Customer implementation b. Strengthen the non bank financial institution - consumer and investor protection c. Strengthen insurance industry d. Strengthen pension fund industry e. Strengthen multi finance industry IV. Capital Market a. capital market development b. government bonds development c. strengthen mutual fund industry V. Others a. development of export financing b. privatization of state owned institution

16

Chapter 2 Macroeconomic Stability

reaching their lowest level; in February 2006. Against this backdrop, retail sales of consumer goods and automotive parts recorded their lowest growth. In addition, the decline in domestic consumption resulted in a decline in production, including demand for imported goods. Natural disasters on some parts of Java Island also had an impact on domestic economic growth, albeit insignificant. To boost economic recovery, the government launched a range of policy initiatives in the form of investment and infrastructure packages in semester I2006 and financial sector packages in the beginning of semester II 2006. However, challenges arose and, therefore, the implementation of these initiatives remained sub-optimal in enhancing the performance of the real economy. An amendment to workforce law, as one of the important parts of the policy package, has been impeded by resistance from the labor unions. Similarly, the other policy packages also fell short of their

coordination and delays in the implementation further exacerbate the recovery of the real economy. Besides, other classic problems have repeatedly impeded real economy performance and, therefore, the high-cost economy continues. These unfavorable conditions have deterred business expansion and new investments. By the end of 2006, these parcels of policy initiatives are predicted to have insignificant impacts on the performance of the real economy and the financial sector. In 2007, however, these policy initiatives will make a significant contribution to enhance investment growth and financial system. The consistency of Bank Indonesia policy has had a profound impact. Domestic inflation eased to 15.5% in June 2006 from 17.11% in December 2005. In addition
Graph 2.6 Inflation, BI Rate and SBI
% 20

expected benefits. The infrastructure package, which represents a long-term initiative and inevitably requires solid coordination among governmental institutions, has been at a standstill, whereas, the financial sector package only began implementation recently. These policy initiatives require strong commitment from the government. Ineffective governmental
15

10

5

0 SBI 1 month -5 2000 2001 2002 2004 2003 2005 2006 Inflation BI Rate

Table 2.3 Growth of Gross Domestic Product
% 2004 Total Private consumption Government consumption Investment Goods and service export Goods and service import Gross Domestic Product
Source: Statistics Indonesia

2005 QI 3.22 (8.52) 14.98 13.39 15.38 6.35 Q II 3.46 (5.61) 13.21 7.29 10.08 5.84 Q III 4.43 16.15 9.18 3.39 9.29 5.34 Q IV 4.18 29.98 1.78 7.41 3.74 4.90

2005 Total 3.95 8.06 9.93 8.60 12.35 5.60 QI 3.24 14.19 2.89 10.75 5.01 4.59

2006 Q II 2.99 31.38 -0.98 11.3 8.31 5.22

4.94 1.95 15.71 8.47 24.95 5.13

17

Chapter 2 Macroeconomic Stability

to inflation target of 8%±1% for 2006, made Bank Indonesia adjusted the BI Rate since May 2006 reaching 12.25% by the end of semester I 2006. This policy was responded to positively by market players as the commitment of Bank Indonesia to curb inflation, despite the probability of a Fed Fund Rate rise. Notwithstanding, owing to the prevailing attractive interest rate differential, the difference in policy measures of the Fed and Bank Indonesia will not trigger potential instability or a capital reversal. The narrow room for Bank Indonesia to maneuver seems to have limited impact on the real economy. On the other hand, the rupiah fluctuated slightly against the major currencies with a volatility of 0.45%. Improvements in country risk exposure as well as a more attractive interest rate differential in Indonesia than other Asian countries, made the rupiah appreciate in May 2006. Notwithstanding, the rupiah relapsed by the end of June due to continuous tight-biased monetary policy in the US as well as regional effect by crashed in Turki and Brazil equity markets. Regional depreciation has also had a profound impact on the rupiah. During the course of semester I2006 the exchange rates of some Asian countries also fluctuated slightly with a generally weakening trend against the USD. Externally, depreciation was also
Graph 2.7 Exchange Rate IDR to US $
Rp/US$ 6000 7000 8000 9000 10000 11000 12000 13000 2000 2001 2002 2003
- Katrina storm in New Orleans (Aug 29, 2005 - World oil price USD 69.81/barrel (Aug 30, 2005) FFR 5% (May 10, 2006)

triggered by the positive expectations of market players on the cycle of the Fed Fund Rate rise. Whereas internally, the low interest rate cycle in Japan made the yen depreciate significantly. This prompted other Asian countries to retain a low interest rate policy to preserve their export competitiveness against Japan. Besides, concern about the situation in South Korea after nuclear weapon trials by North Korea and an unfavorable political situation in Thailand were two driving factors of regional currency depreciation. The balance of payments in Indonesia has improved despite slight upward pressures of external risk exposure. Throughout the first quarter of 2006, trade and current account balances recorded a surplus due to augmented in exports; predominantly stemming from the surge in oil-gas and non oil-gas prices. Conversely, imports dropped significantly, owing to the substantial decline of oil-gas imports. This is supported by oil consumption efficiency since oil price hikes in 2005. Moreover, weaker purchasing power restrained import demand of either final and intermediate goods. The early termination of debts due to the IMF made the balance of payments and fiscal condition healthier. This was also supported by a surplus in the capital account that is forecast to grow significantly and, therefore, substantially expand the international reserves of Indonesia to USD40.1 billion in semester I-2006. The surplus has been due to a substantial amount of capital inflows, predominantly to domestic equity and bond markets. Considering the returns in domestic financial markets, optimistic macroeconomic expectations as well as low country risk, Indonesia remains attractive for international investors and, thus, attracted more capital inflows. Notwithstanding, Indonesia has been strongly vigilant over the risk of capital reversal, as the surplus

2004

2005

2006

predominantly stems from short-term portfolio

18

Chapter 2 Macroeconomic Stability

Table 2.4 Balance of Payment
Billions of US$ 2004 2005 Q1 I. Current Account A. Goods, net (Trade Balance) 1. Exports, fob 2. Import, fob B. Services, net C. Income, net D. Current Transfers, net II. Capital & Financial Account A. Capital Account B. Financial Account 1. Direct investment a. Abroad, net b. In Indonesia (FDI), net 2. Portfolio investment, net a. Assets, net b. Liabilities, net 3. Other investment a. Assets, net b. Liabilities, net Memorandum: Reserve Assets Position (In Months of Imports & Official Debt Repayment) Current Account (% GDP) Debt Service Ratio (%) 1,564 20,152 70,767 -50,615 -8,811 -10,917 1,139 1,852 n.a. 1,852 -1,512 -3,408 1,896 4,409 353 4,056 -1,045 985 -2,030 36,320 5.7 0.6 27.1 340 22,323 86,179 -63,856 -10,792 -12,447 1,257 -2,579 333 -2,913 3,042 -3,065 6,107 4,236 -1,080 5,316 -10,190 -8,646 -1,544 34,724 4.6 0.1 22.1 2,564 8,733 23,146 -14,413 -3,298 -3,248 378 537 41 496 -171 -655 484 3,710 -392 4,102 -3,043 -1,456 -1,587 40,082 4.6 24.9 Q2 1,980 8,683 25,274 -16,591 -3,226 -3,608 131 -911 56 -967 -137 -628 491 -1,222 -471 -751 392 1,861 -1,469 40,107 4.6 34.3 2006* Q3 1,949 7,649 25,563 -17,913 -2,680 -3,344 324 327 152 175 549 -745 1,294 824 -24 848 -1,197 -1,845 647 41,916 4.8 20.5 Q4 2,152 7,376 25,003 -17,627 -2,591 -2,953 320 -429 152 -581 -119 -911 792 837 -29 866 -1,299 -2,909 1,610 43,262 5.0 23.8 Total 8,646 32,442 98,985 -66,544 -11,796 -13,153 1,152 -476 400 -876 122 -2,940 3,061 4,149 -916 5,065 -5,147 -4,348 -799 43,262 5.0 2.6 25.8

investments. In addition to the portfolio investments, foreign direct investment to Indonesia is forecast to slightly expand by year end. Accordingly, improved balance of payments and fiscal conditions will insulate Indonesia from externalities. The near-term forecast of macroeconomic stability is positive supported by an easing of inflationary pressures, declining domestic interest rates, more stable exchange rates, and expanding international reserves. Besides, the credit rating of Indonesia has also improved, which reflects positive developments in the macro economy and in terms of country risk. The higher credit rating is due to enhanced fiscal and external conditions given the budget surpluses and declining public debt burden. Taking this positive development into account, both direct and indirect foreign investment will predictably escalate during the course of
70 65 60 55 50 45 40 35 30 Aug Nov 2003 Feb

Graph 2.8 Country Risk of Indonesia

Political Risk Economic Risk

Financial Risk Composite Risk

May Aug 2004

Nov

Feb

May 2005

Aug

Nov

Feb May 2006

Source: International Country Risk Guide

semester II-2006. Besides, economic turnover is supposed to take a leap forward as the government has launched a policy package to improve the investment climate, infrastructure and the financial sector. Nevertheless, to be effective, strong commitment from the government in the

19

Chapter 2 Macroeconomic Stability

Graph 2.9 Expected Inflation for the Next 6 Months
Net balance 160 140 120 100 80 60 40 20 0 2001 2002 2004 2003 2005 2006 -50 Retail Selling survey Consumer Survey Survei Kegiatan Dunia Usaha (lhs) 150 100 Net balance 200

moving considering the challenges faced in infrastructure, particularly energy supply. This has been reflected by investment plans that appear to contract in the near-term. Besides, the conjuncture of the global economy predominantly the global oil price, interest rates, shortterm capital inflows, exchange rates, and regional capital markets- will increasingly determine the state of the domestic economy. The state of the near-term global economy is exacerbated by the political tension in the Middle East. These determinants will engender upward

50 0

Note : Adjusted calculation in 2004

implementation of the policy package is a top priority. On the other hand, domestic investment will remain slow-

risk pressures on the presently stabilizing domestic macroeconomy and financial sector.

20

Chapter 3 Corporate and Household Sector

Chapter 3 Corporate and Household Sector

21

Chapter 3 Corporate and Household Sector

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22

Chapter 3 Corporate and Household Sector

Chapter 3 Corporate and Household Sector

The increasingly stable macroeconomy of Indonesia had a positive influence on the performance of the corporate sector, albeit the effects on employment and growth remain sub-optimal.

Corporate performance has improved in Q1 2006, in line with diminished risk pressures. Increasing rentability and financing cash flow lead to optimism on future corporate performance. Government support to improve investment policy and reduce high cost economy was expected to have significant positive impact for the economy and to foster economic growth. On the household side, oil price shocks in October 2005 has undermined the purchasing power of consumers. Additionally, extensive lay-off by corporate sector and stagnant job vacancies as well as income level has contributed to exacerbate the repayment capacity of consumers. This condition put upward pressure on consumer loan risk, particularly on credit card along with significant increase of interest rate which curbed demand for conumer loan.

industrial property lease- undermined investment in the corporate sector. Notwithstanding, consistency from Bank Indonesia in implementing monetary policy effectively curbed inflationary pressures, as reflected by the narrowing spread of nominal and real interest rate as well as macroeconomic stability. Besides, corresponding to supportive government initiatives to enhance the investment climate, including the amendment of investment and labor laws as well as the postponement of an electricity tariff increase, working capital and investment loans received a boost. Additionally, the ratio of non-performing loans is falling. During the first quarter of 2006, working capital and investment loans increased, albeit at slower rates.
Graph 3.1 Amount and NPL of Working Capital & Investment Loan
40 30 % % 40 30 20 10 0 -10 -20 -30
Working Capital Loan-Growth (lhs) NPL Working Capital Loan (rhs) Investment Loan-Growth (lhs) NPL Investment Loan (rhs)

CREDIT RISK IN THE CORPORATE SECTOR
Credit risk in the corporate sector has started to decline in line with the improvement in repayment capacity
Inflationary pressures stemming from oil price shocks in quarter IV-2005 generated second-round effects in semester I-2006. Price hikes √including raising the

20 10 0 -10 -20 -30 -40 -50 -60

-40 -50 -60

2000

2001

2002

2003

2004

2005

2006

23

Chapter 3 Corporate and Household Sector

Graph 3.2 Corporate Financial Indicator
%
Current Ratio
240 200 160 120 80 40 0

Graph 3.4 Growth of ROA and ROE
800 700 ROA ROE

DER

ROA

600 500 400 300 200

Collection Period Base year 2002=100
Source: Jakarta Stock Exchange

ROE Q1:2005 Q1:2006

100 0 -100 Q1 Q3 2001 Q1 Q3 2002 Q1 Q3 2003 Q1 Q3 2004 Q1 Q3 2005 Q1 2006

Inventory Turn Over Ratio

Source: Jakarta Stock Exchange

Although real interest rates for loans were close to 0%, the relatively high cost of financing scuppered demand for working capital and investment loans. As a consequence, credit growth has continuously slowed down. Notwithstanding, the credit risk associated with investment loans diminished, whereas, for working capital loans the risk increased slightly, as confirmed by the nonperforming loan ratios. As a result of oil price shocks in October 2005, domestic consumer demand turned sluggish. On the other hand, the cost of production predominantly related to energy- grew significantly. Such adverse conditions slashed the profit margin and undermined the repayment capacity of corporate debtors up to the first quarter of 2005. However, they quickly began to rebound in the second quarter of 2006.
Graph 3.3 Corporate Loss Ratio

The financial performance of the corporate sector showed slight improvement in terms of better profitability and liquidity compared to the previous year, shown by healthier ROA. This was also reflected by a drop in the number of businesses that recorded losses. With the exception of basic industry, in general, all industries reported a decreasing trend in the number of businesses recording losses. In addition, the mining industry was the best performer given the least number of companies recording losses. The driving factors behind the superior performance of the mining sector include: (1) efficiency enhancement by shifting energy sources and organizational restructuring; and (2) rising mining prices in global commodity markets. In addition, the liquidity of the corporate sector improved as evidenced by a healthier ratio
Graph 3.5 Cash Flow
Millions of Rp 500 400 300 200 100 0 -100 -200 -300 -400 -500
Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1

0.70 0.60 0.50 0.40 0.30 0.20 0.10 0.00
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

Operating activities Investing activities Financing activities

2003 property mining
Source: Jakarta Stock Exchange

2004 consumption infrastructure agriculture basicindustry

2005

2006

2000
Source: Jakarta Stock Exchange

2003

2006

miscindustry trading

24

Chapter 3 Corporate and Household Sector

Graph 3.6 Corporate Leverage
DER 1.8 1.6 1.4 1.2 0.3 1 0.8 0.6 Q1 Q2 Q3 2003 Q4 Q1 Q2 Q3 2004 Q4 Q1 Q2 Q3 2005 Q4 Q1 2006 DER Debt/TA 0.2 0.1 0 Debt/TA 0.7 0.6 0.5 0.4

Graph 3.8 Plan of Investment
% Respondent 40 35 30 25 20 15
Plan of Investment Estimation of investment Sem I Sem II Sem I

Net Balance 70 65 60 55 50 45 40

10

Sem II

Sem I

Sem II

2003

2004

2005

2006

Source: Jakarta Stock Exchange

of current assets. The improvement in corporate profitability and liquidity indicated the potential to enhance the repayment capacity. This will enable the financial sector to better mitigate credit risk as NPL will predictably fall in the near-term. On the other hand, corporate leverage has slowed compared to the previous year, as shown by the decreasing debt-to-equity and debt-to-total assets ratios. This was supported by an increase in financing cash flows as a result of initial public offerings and rights issues totaling Rp6.5 trillion. Financing from bond issuance also rose by Rp3.6 trillion. The increase in financing cash flows indicated that business expansion and investment is imminent, as shown by the positive business confidence index and investment plan concurrent with declining
Graph 3.7 Business Survey
Net Balance 50 45 40 35 30 25 20 15 10 5 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

country risk. The emergence of positive expectations towards investment plans has also been supported by policy initiatives to enhance the investment climate, infrastructure and financial sector. To this extent, strong commitment and effective coordination among the authorities are essential, as a poor investment climate has been a major impediment. Additionally, optimistic expectations of inflation, domestic interest rates, and stable exchange rates have also been supporting factors. As a result, investment and business expansion is forecast to rebound strongly in 2007. The challenges remain, however; increases in administered prices, including basic electricity tariffs and fuel prices, as well as the smuggling of consumer goods to domestic markets that expose the domestic economy to unprecedented risks.

CREDIT RISK IN THE HOUSEHOLD SECTOR
Credit risk in the household sector was moderate with a likelihood of increasing in line with weaker purchasing power.
In line with the dwindling consumer demand, growth in consumer loans continued to decelerate in semester I2006. Oil price shocks and interest rate hikes in October

Business Situation

Financial condition

6 Month Business Expectation

2005 had adverse impacts on the purchasing power of the household sector. Expensive cost of funds and a higher

2002

2003

2004

2005

2006

25

Chapter 3 Corporate and Household Sector

Graph 3.9 Consumer Loan & NPL
100 80 60 40 20 0 -20 Consumer Loan-Growth (lhs) -40 2000 2001 2002 2003 2004 2005 2006 NPL(rhs) -4 % %

Graph 3.11 Lay-off
Thousand people
10 8 6 4 2 0 -2

140 120 100 80 60 40 20 2001
Source: Depnakertrans *) Until Semester I

2002

2003

2004

2005

2006 *)

cost of living weakened demand for consumer loans and exacerbated the repayment capacity of consumers. Additionally, rising residential property inflation also hampered demand for mortgages. On the income side, the household sector was hit by scores of employee dismissals following streamlining measures taken by the corporate sector subsequent to the oil price shocks. These dismissals undercut their repayment capacity. Highest layoff was in forestry, textile & textile product, shoes, construction and tourism industry. This trend was due to the structural problem in the respective sectors, such as illegal logging in timber industry and smuggling in textile & textile product industry. The increment lay-off level was predicted about 2% higher than that of the previous semester. Accordingly, total number of open unemployment rose to 11.1 million people, put an upward
Graph 3.10 Residential Inflation
% 14 12 10 8 6 4 2 0 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 2000 2001 2002 2003 2004 2005 2006

pressures on credit risk for consumer loans. This condition was reflected in NPL of consumer loan which tended to increase significantly in semester I 2006. Credit risk associated with mortgages and credit cards also showed a growing trend. Consumer property increased significantly, yet followed a growing trend of distressed loans, which they remained below the acceptable threshold of 5%. Notwithstanding, credit risk exposure for households emerged from credit card financing, as the vast majority of card holders are low income earners. From the total number of credit card holders, 55.52% earn a monthly income of Rp1-2 million. With monthly interest rates of 3.25-3.75% or 39.0-45.0% per annum and the escalating cost of living, credit risk from credit cards is becoming alarming. Non-performing loans for credit cards totaled Rp18.1 trillion or 2.5% of
Graph 3.12 Mortgages (House & Apartment)
Billions of Rp 70,000 60,000 50,000 40,000 30,000 20,000 10,000 Dec 00
Note :

% 7 6 5 4 3 2 NPL (rhs) Value (lhs) 1 0

Dec 01

Dec 02

Dec 03

Dec 04

Dec 05

Dec 05

26

Chapter 3 Corporate and Household Sector

Graph 3.13 Consumer Confidence Index

Graph 3.14 Consumer Expectation for the Next 6 Months

Net Balance 160 140 120 100 80

Net Balance 180 160 140 120 100 80

60 40 20 0
Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun

60
Consumer expectation Consumer confidence index Recent economy condition

40 20 0
Mar Jun Sep Dec Mar Jun Sep Dec Mar

Income Economy condition Job Availability
Jun Sep Dec Mar Jun

2003

2004

2005

2006

2003

2004

2005

2006

total loans. Despite the segment»s modest size, growing credit risk associated with credit card financing will threaten banking sector unless strong vigilance is exercised. In the near future, with lower inflationary pressures, household consumption is forecast to expand and, therefore, contribute to greater economic growth. Easing inflationary pressure will have profound effects on relaxing monetary policy. Nevertheless, monetary relaxation will not promptly lessen the interest rate of credit, therefore

demand growth for consumer loans will slow down. Furthermore, banks are planning to revise their targets for consumer loan expansion, a condition that potentially decelerates consumer loan growth. Moreover, consumer confidence has started to emerge, albeit consumption appears not to materialize in the near-term. To stimulate purchasing power and demand, fiscal stimuli from the government, such as income tax reduction and direct cash subsidies for the poor, are essential.

27

Chapter 3 Corporate and Household Sector

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28

Chapter 4 Financial Sector

Chapter 4 Financial Sector

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Chapter 4 Financial Sector

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30

Chapter 4 Financial Sector

Chapter 4

Financial Sector

Financial system stability was remained, despite upward risk pressure triggered by the fuel price hikes. Financial institutions continuously performed well despite restrained intermediary function.

The stability of Indonesian financial system lingered despite experiencing slightly shocks in the capital market. Intermediary function of the financial sector was restrained, as reflected by a significant decline in financing growth. Rising interest rates coupled with deteriorating public purchasing power lead to a decline in financing demand and quality. Nevertheless, banking sector showed resiliency. Banks had limited exposures of market and liquidity risks, and therefore, these risks did not generate disruption in banks. Banks have been well-capitalized and maintained steady profitability, making them capable to dampen various risk pressures. Furthermore, restrained intermediary function by banks caused a decline in business activities and the profitability of multi-finance companies. Moreover, mutual funds market rebounded after substantial redemptions in the previous year. The stock market experienced a bullish rally for a short time but was corrected near the end of 2005 because of a rise in the Fed Fund Rate and regional effects. The bullish trend in the equity market was triggered by foreign investors» movement; a similar condition also occurred in the government bond market. On the other hand, corporate bond market was less active. Bank Indonesia exercises strong vigilance over

intensive transactions by foreign investors, as this is prone to sudden capital reversal.

BANKING
Despite upward risk pressures, the stability of banking sector remained positive.
Intermediary function of banks remained positive despite slowed significantly due to a rise in credit risk pressure. This is an impact generated by the sharp decline in public purchasing power attributable to sharp hikes in domestic fuel prices. On the other hand, liquidity risk and market risk pressures were not significant and well managed. The application of a limited guarantee scheme to public savings has not yet indicated significant migration
Graph 4.1 Credit growth, Deposit, and LDR
% 80 70 60 50 40 30 20 10 (10) 2001 2002 2003 2004 2005 2006
Loan to Deposit Ratio Loans Deposits

31

Chapter 4 Financial Sector

in banking. On the contrary, banking liquidity increased as the interest rate remains high. Overall, emerging risks did not disrupt profitability or capitalization, which helped to maintain banking sector resilience.

attributable to the rise of interest rates, on the other hand, credit growth significantly slowed down. Beside credits, banks had substantial portions of portfolio in government bonds (SUN) and Certificate of Bank Indonesia (SBI), with share of 24.7% and 10.9% respectively. This portfolio

Intermediary Function
The intermediary function of banks remained positive, albeit decelerating, reflected by continuously declining credit growth reaching 14.9% (y-o-y). Such credit growth is still far below targeted growth in the bank business plan set at 18% in 2006. This development is the result of the rise in interest rates, weaker public purchasing power, and unfavorable economic conditions brought about by the sharp hikes in domestic fuel prices in October 2005. Moreover, inadequate implementation of the policy to improve the investment climate did not boost demand for investment credits. Statistically, high interest rates supported the acceleration of credit repayments, while disbursing new credits weakened, leading to relatively low net credit growth. This indicates a tendency of contracted economy activity. In addition, high interest rates as well as a rise in production and living costs impinged on NPL. The loan-to-deposit ratio (LDR) stayed at 64.8%, reflecting the fact of the remaining slow growing intermediation. The growth of bank funding accelerated
Graph 4.2 Sectoral Credit Growth

structure, nevertheless, was a sign of the remaining suboptimal support of banking sector to the real economy. Throughout the first semester of 2006, credits in all sectors of economy showed lower growth (y-o-y) than the previous year. This was attributable to the January

Effect, where all companies are usually preparing for the
commencement of business plan implementation, whilst waiting for the direction of macro economy development. Driven by robust demand, credits for construction and trading sectors were buoyant, achieving 18.3% and 18.24% respectively. On the other side, credit for manufacturing sector -the prime mover of the economyrecorded lower growth to 9.78% (y-o-y). The falling credit demand reflected the second round effect of the hikes in fuel prices and domestic interest rates, a condition triggering escalation of production and living costs. Credit for property ownership has stayed upbeat, attributable to the growth of residential mortgage. Banks have increasingly shifted towards consumption credit despite being hampered by lower demand in the first half of 2006. Consumption credit

Graph 4.3 Growth of Property Loans
% 80

Electricity Mining Social Services Services Agrobusiness Contruction Transportation Manufacturing Trading

60 40 20 0 -20 -40 -60
June 2006 June 2005 0 10 20 30 40 50 60 %

-80 -100 1998 1999 2000 2001 2002 2003 2004

Real Estate Construction Mortgage

-10

2005

2006

32

Chapter 4 Financial Sector

recorded the highest growth despite its deceleration to 16.2% (y-o-y) from 36.81% (y-o-y). High cost of funds due to the spike in domestic interest rates impeded demand for consumption credit. This incited a mounting pressure on consumer credit risk due to lower consumer repayment capacity coupled with mounting inflationary pressures. Nevertheless, consumption credit has been more profitable and secure, and consequently, banks have maintained growing portion of their portfolio in this segment. Against this backdrop, the consumption credit grew to around 29.5% of total aggregate credit. The primary driven was mortgages, which showed growth of 33.5% (y-o-y) and led to a share of 31.2% of total consumption credit. Credit for vehicle ownership as well as unsecured personal loans expanded rapidly; a condition demanding stronger surveillance. Demand for working capital credit remained steady, as reflected in its unwavering growth attributable to a steady growth in trading sector. As a result, at the end of semester 1 2006, working capital was the largest portfolio of most banks, reaching 51% of total credit. This has been a sign of remaining positive economic activities amidst slowing down. In the meantime, the growth of investment credit has continued to show a downward trend since 2004, achieving only 6.2% (y-o-y). Low investment credit growth indicated remarkably low
80 60 40 20 0 -20 -40 -60 2000 2001 %

Graph 4.5 Credit Growth per Type

Consumption Loan Working Capital Loan Investment Loan

2002

2003

2004

2005

2006

investment activities. In addition to lower public demand, low investment credit growth was also attributable to unfavorable investment climate, including the substandard infrastructure, in particular electricity. Nevertheless, implementation of policy package to improve infrastructure remained sub optimal as realization of investment fell short to meet the target. Conversely, credit to micro, small and medium-sized enterprises (MSME) showed buoyant growth. Retail sector, such as MSME, become a preferred outlet in banks» portfolio as this sector proved to be more resilient to shocks. This was reflected by MSME credit growth achieving 18.2% (y-o-y); notwithstanding, it was lower than the previous semester (25.2%). Such a movement bolstered the MSME credit share amounting to 26.1% of total banking credit. Nonetheless, incentives for MSME financing expansion through the banking policy package of January 2006 appeared to be underutilized by banks,

Graph 4.4 Type of Credit
% 100

except those with existing networks in the MSME financing segment. Although the MSME segment has been relatively higher resilience compared to other

80 Working Capital (51.5%) 60

segments, not all banks were able to enter this segment, considering that the efficiency level of banks differs. Working capital was the largest portion of MSME credit

40 Investment (19%) 20 Consumer (29.5%) 0 2000 2001 2002 2003 2004 2005 2006

and investment credit remained small. Banking intermediary function is forecast suboptimal in the next half of 2006, despite the decline in BI

33

Chapter 4 Financial Sector

Graph 4.6 Growth of Loans to SMEs
% 40 35 30 25 20 15 10 5 0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

Graph 4.7 Gross NPL
% 12 10.1 9 10.6 Dec'05 Jun'06

6 3.7 4.0 3 3.5 3.9 3.7

5.0

4.5 4.6

Working Capital Loan

Investment Loan

Total

0 Large Bank Medium Bank Small Bank Joint Venture Foreign Bank

2005

2006

and savings rates. This is related to the rigidity in credit interest rate, attributable to the relatively high cost of funds, particularly in overhead costs including insurance premium for deposit insurance scheme and technology. In addition, banks are focusing their efforts in consolidation as this is accelerated by incentives, among others in the form of tax relief, as stated in the financial sector policy package. Banks will be entitled to incentives for those make successful consolidation in the form of mergers and acquisitions up to 2008. Third, debtors will likely to wait and see. The signal of a continuation interest rate decline cycle will prevent debtors to promptly demand for credit and shift their expectation, as they will wait for better rates.

foreign-currency denominated credits showed high NPL, reaching 21.9%, compared to those of rupiah denominated, which was just 6.2%. Notwithstanding, the stability of banking sector will not be in disruption, as the share of foreign currency denominated credits is relatively insignificant (18.0%). Domestic banks held only 12.6% of foreign currency denominated loans, while other, including foreign and joint-venture banks held (46.1%) and (58.0%) respectively. Persisting fundamental economic problems such as those related to taxation, legal assurance, investment and infrastructure intensified credit risk pressures. Despite facing this high pressure, the real sector, in general, survived and grew. Moreover, enhanced risk management capability of banks and prudence helped to mitigate the acceleration

Credit Risk
In addition to the decelerating intermediary function, credit risk pressures inclined to increase as gross NPL rise from 8.3% at the end of 2005 to 8.8, peaking in March 2006. This was a secondary effect of various macroeconomic shocks including the hikes in fuel prices and sharp rises in the interest rate in 2005. Due to the remaining sub-optimal business prospects, NPL have remained concentrated on corporate segment, particularly at two large banks. Gross NPL will drop to below 5%, excludes the two large banks. Moreover,

of NPL ratio. Increased credit risk pressure caused banks
Graph 4.8 Net NPL
% 8 6.0 6.3 Dec'05 Jun'06

6

4 2.5 2 2.8 2.9 2.5 1.6 1.1 0 Large Bank Medium Bank Small Bank Joint venture 0.8 3.0

Foreign Bank

34

Chapter 4 Financial Sector

Graph 4.9 Non Performing Loans
% 12 10 8 6 NPL Gross (lhs) 4 2 NPL Net (lhs) Billions of Rp Credit (rhs) 800 700 600 500 400 300 200 100 Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun 2002 2003 2004 2005 2006 0
40 80 100

Graph 4.11 Non Performing Loans - per Business Sector
% Other industries Others

Business Services 60 Trading

20 0 1996

Manufacturing

1997 1998

1999

2000

2001

2002

2003 2004

2005

2006

Others industries = transportation, construction, agriculture, mining, social service, dan electricity

to be reluctant to allocate credits to the corporate sector, since the historical probability of default in this segment is higher compared to other segments. In addition, impediments in legal resolution since the crisis period caused the settlement of NPL in this segment to become very slow and expensive. Credit to manufacturing industry recorded the highest gross NPL with a declining trend reaching 15.3% and credit share (42.4%) of foreign currency-denominated credit. Overall, share of manufacturing industry credit reaching 23.8%, indicated that credit risk pressure from this sector requires strong vigilance and prompt resolution. Weaker purchasing power exacerbated conditions in the industrial sector. The timber industry, as well as the textile and textile products industry showed high NPL, as a consequence of a limited wood supply and substantial
Graph 4.10 Non Performing Loans - Foreign Currency & Rupiah Denomination
% 45 40 35 30 25 20 15 10 5 0 2000 Rupiah 2002 2003 2004 2005 2006 Total

textile imports competition from China. In addition, the trade sector also showed a significant rise in NPL, reaching 7.52% from 5.50% at the end of 2005. A decline in the credit quality of the trade sector indirectly influenced working capital credit quality, for which NPL reached 8.40%. As per usage, investment credits recorded the highest NPL, achieving 16.1%, a slight rise from its previous position. The accelerating credit risk pressures attributable to the impaired loans of corporate debtors, particularly at two large banks, despite rescheduling, reconditioning and restructuring efforts. A portion of the NPL, among others, stemmed from un-restructured IBRA credits. However, in general, gloomy economy as well as imprudent risk management was the major factors behind rising NPL of investment credits. On the other hand, consumption credits showed the lowest credit risk
Graph 4.12 NPL of Trading and Manufacturing
% 60
Trading

50

Foreign Currency Denominated
40 30 20 10 0 2001 2002 2003 2004

Manufacturing

2005

2006

35

Chapter 4 Financial Sector

Graph 4.13 NPL - Industry Manufacturing
% 60
Garment

Graph 4.15 Gross NPL of SMES
% 10 9 8 7 6

50 40 30 20 10 0 2001 2002 2003 2004

Wood working Food and beverage

5 4 3 2 1 0
NPL - Working Capital NPL - Investment NPL Total

2005

2006

2004

2005

2006

pressure, in spite of experiencing a rise in NPL from 2.2% to 3.2%. This was attributable to high inflation, an imbalanced condition to household income rise, aside from the rise in interest rates. These factors influenced household repayment capacity. Even though the total consumption NPL ratio was still within the tolerance limit of 5%, allocating credits through credit cards showed the highest consumption credit risk reaching an NPL ratio of 10.8%. The highest NPL was for foreign banks with a high consumer credit share, specifically in the form of credit cards. The rising tendency of this NPL ratio requires vigilant management considering that credits through credit cards are unsecured credits. Similar to the corporate segment, the MSME segment experienced a rise in credit risk with a rise in NPL ratio from 5.9% to 7.4%. Although MSMEs tend to show high resilience to economic shocks, the sharp hikes in fuel prices

and the interest rate in October 2005, nevertheless slowed down MSME activity. Such a condition is a reflection of the substantial share of MSMEs in the trade sector; reaching 49.9%. Consequently, any decline in purchasing power weakens MSME performance, specifically the trade sector as shown by a sharp rise in the NPL from 3.9% to 7%. This is mainly contributed by working capital credits with NPL reaching 6.95%. Property credit quality experienced a decline with upward risk pressure stemming from an NPL rate reaching 6.4% from 5.3%. However, this did not lead to instability considering the relatively small share property credit has. Mortgages, as the largest share of property credit, showed the highest credit quality, but also experienced a significant leap in NPL reaching 3.8% from 2.4%, in line with the considerable decline in consumer repayment capacity. The highest NPL rate, previously held by credits for construction projects, shifted significantly to real estate credit, reaching

Graph 4.14 Growth of NPL as of type
% 200 Working Capital 150 100 50 Investment Loans Consumer

13.4%. In line with improvements in macroeconomic conditions, declining cycle in the interest rate and country risk, banks will rebound their intermediary function in the second semester of 2006. Moreover, the implementation of the improvement package for the investment climate,

0

infrastructure and financial sector will drive demand for
-50 -100 2000

bank financing. However, it is estimated that a high
2001 2002 2003 2004 2005 2006

acceleration in credit growth will not occur considering

36

Chapter 4 Financial Sector

Graph 4.16 Gross NPL
(%) 35 30 25 20 15 10 5 2002 2003 2004 2005 2006 Real Estate Construction Property Mortgage

the rigidity of credit interest rates up to year end. Furthermore, it is forecast that credit demand will rise, specifically in infrastructure, as well as the agricultural/ plantation and mining sectors, considering the bright prospects offered by these sectors. Credit quality is forecast to improve in line with better corporate financial performance and credit restructuring. Notwithstanding, credit risk in disaster stricken areas will rise, specifically in the Lapindo hot mud case.

37

Chapter 4 Financial Sector

Box 4.1

Impacts of the Earthquake in Yogyakarta on Financial Stability

Based on experiences from the Bali bomb incident and the tsunami disaster in Aceh, the earthquake in Yogyakarta will not threaten financial stability. This is due to relatively modest systemic risk. Inter-bank obligations between local banks are relatively small since banks in this area are branch offices. Furthermore, the quantity of credits channeled to the area is not substantial and primarily extended to the retail sector. Nevertheless, the deceleration of the intermediary function and a potential rise in NPL in the area are inevitable.

industries or micro, small and medium-sized enterprises (MSME), prevailingly trade sector, -working capital credits-. Consumption credits have the highest share compared to other types of credits. Prior to the earthquake, credit quality in DIY was good with far less NPL compared to the banking industry. Deposits at banks are dominated by savings and time deposits, primarily originated from Yogyakarta City reached 73.3% and Bantul City was only 4.1%. Therefore, if a rush of depositors occurs in Bantul City, it will not affect the liquidity of banks in DIY.

Banks in the district of Yogyakarta (DIY)
The earthquake in the district of Yogyakarta (DIY) on 27th May 2006 took substantial human victims and ruined property. It influenced the economic condition of DIY, including banking. There are 362 bank offices in the area from 25 banks and one local bank with a head office in DIY. A part of the outstanding credits in DIY are assets of banks with offices outside DIY. Credits in DIY represents only 0.8% of total national banking credit, while deposits amount to 1%. Typically, economic activity in DIY consists of small

The only local bank in DIY has total assets of Rp2.0 trillion or 0.14% of total banking assets. Credit quality at the bank is very good, as shown by an NPL rate of only 1.6%. Pooled funds at the local bank predominantly consist of demand deposits and savings.
Graph Box 4.1.1 Sectoral Credit - DIY
3.0%0.4% 9.8% 48.0% Agriculture 0.0% 3.1% Mining Industry Electricity Construction Trading 23.7% Transportation Comercial service Social service Others

Table Box 4.1.1 DIY Banking Statistic (April 2006)
Loans Total Loans Share - Loans in Bantul - SME - Trading - Working Capital - Consumer Loans Gross NPL Rp. 5.9 Triliun Deposits Total Deposits Share Rp. 11.7 Triliun
Consumer

2.4%

8.1%

1.5%

Graph Box 4.1.2 Type of Credit - DIY
Working Capital

15% 85% 23.70% 38.50% 47% 3.90%

- Saving 43.1% - Deposits 38.1% - Demand Deposits 1.8%

47.0% 14.5%

38.5%

Investment

38

Chapter 4 Financial Sector

Table Box 4.1.2 Bank Loans and Deposits in Yogyakarta ( April 2006 )
Loans Total Loans Rp. 1 Triliun Loans in Bantul Rp. 214.5 Miliar NPL 1.6% Deposits Total Deposits Rp. 1.7 Triliun share - Saving 31.8% - Deposits 24.7% - Demand Deposits 43.6%

Rp218.2 billion. Since bank»s current profits is inadequate, the remaining provisions have to be taken from the capital. This leads to a drop in CAR far below the minimum set of 8%, although it will not become negative. Based on bank regulation regarding specific treatment for bank credits after a natural disaster will somewhat mitigate the impacts described above. If such a scenario causes conditions of the local bank to

Worst Case Scenario of Credit Quality in Bantul
The vast area in Bantul is devastated by the earthquake. Outstanding credit located in the area amounted to Rp866.1 billion, channeled by 37 banks and 138 bank offices. Trade sector credits as well as working capital credits and consumption credits, recorded major share. Assuming that subsequent to the earthquake all credits in the Bantul area become default, gross NPL will experience a modest rise to 9.3%. Such a rise will not significantly influence the banking system stability, considering small share of credit in Bantul. This scenario was created by performing a simulation on one local bank and other commercial banks. For one local bank, if all credits become defaults, NPL will rise to 22.0%, which is far above the average would require additional provisions amounting to

deteriorate, bank solvency will remain good as it has a liquid asset portfolio consisting of government bonds (SUN) Rp195.7 billion and Fasbi Rp359.3 billion, as well as cash. Credit allocated in Bantul area by other banks represents only 0.1% - 0.4% of total bank credits. Using the same scenario mentioned above, Gross NPL rate will rise slightly to 0.01% - 0.036%, so that the deficiency of provisions can be covered by current year profits. Therefore, pressures in NPL will not influence capital as banks recorded high CAR. Based on such an analysis, the impact of the earthquake in DIY will not generate financial system instability. Nevertheless, sluggish recovery and hampered credit allocation are inevitable, hindered economic development in the area.

39

Chapter 4 Financial Sector

Box 4.2

The Threat of Hot Mudflow in Porong-Sidoarjo on Financial Stability

Following the earthquake in Yogyakarta and the surrounding area, Indonesia faced yet another catastrophic incident in the form of a high pressured mudflow eruption. The mudflow began on 29th May 2006 and persists to this day. The eruption stems from an exploratory oil and gas borehole known as Banjarpanji1, located in Porong-Sidoarjo, East Java, owned by PT Lapindo Brantas. The ever increasing volume of the mudflow and the contagion effects in the surrounding area are accumulating and aggravating local economic activities as well as the financial system in the area. 6. 5.

represents the fastest transportation lane to the seaport, has severely hampered product distribution. The resulting detour has raised transportation costs and docking fees. The mudslide is estimated to have destroyed 360 hectares of prime agricultural land including plantations. In addition, 1,800 aquaculture fishponds have been destroyed. The devastation caused to property supply and demand as well as the expected resulting increase in real estate NPL funded by banks is estimated to affect 4,709 debtors at two major banks.

Impact on Local Activities
Short-term immediate impacts: 1. Houses and whole villages have been inundated in the area surrounding PT Lapindo Brantas. Furthermore, the radius of the affected area continues to expand, engulfing the villages of Jatirejo, Rono Kenongo, Siring and Kedung Bendo with a total population of 9,789. This has displaced residents and sparked a serious social crisis. 2. Nineteen factories employing approximately 1,873 staff have been forced to close. Consequently, the unemployment rate has soared, thus undermining economic growth. 3. Numerous micro, small and medium enterprises (MSME) have been devastated. The area was previously considered an artisan centre for leather, silver, etc. 4. The closure of the Gempol-Surabaya toll road, which passes through the affected area and

7.

Tourism in East Java, particularly in Malang and other well-established tourism areas has witnessed a dramatic decline. The medium-term impacts of the mudflow include

a decline in business and economic activities, which will raise banking NPL in East Java. This will discourage foreign investors from East Java, thus disrupting regional income. Eventually, this could affect national income, considering that East Java contributes significantly to Gross Domestic Income (GDP).

Impact on Compensation Claims
PT Lapindo Brantas is owned by PT Energi Mega Persada Tbk (Bakrie Group) with an ownership share of 50%, Medco 32% and Santos 12%. The contribution of PT Energi Mega Persada (oil and gas) and its subsidiary companies to the Bakrie Group is substantial; ranked third behind the coal sector (Bumi Resources) and infrastructure/telecommunications (Bakrie & Brothers).

40

Chapter 4 Financial Sector

With such strong business integration within the Bakrie Group, group financial performance could be adversely affected. The Bakrie Group is estimated to own assets totaling over Rp32 trillion with Rp10.2 trillion in outstanding debt, more specifically Rp5.3 trillion in the coal mining sector, Rp2.88 trillion for oil and gas and Rp1.2 trillion for infrastructure and manufacturing. The outstanding debt owned by the Bakrie Group primarily stems from bank loans. This could destabilize the banks involved should PT Lapindo»s problems not be resolved immediately. Under its terms of operation, PT Lapindo Brantas is insured against the possibility of loss. However, the amount of insurance that will be paid out by the insurance consortium is estimated to total no more than US$25 million (Rp237.5 billion), which falls well short of the loss incurred by PT Lapindo Brantas. Furthermore, should the company be deemed liable, PT Lapindo will be unable to settle the compensation claims made by the affected population. The assets of PT Lapindo are insufficient and the losses continue to escalate. Therefore, the losses could affect the Bakrie Group as a whole. The consortium will be responsible to partially bare the costs of the loss as long as the mudflow is deemed not due to an act of God/ force majeure.

credit quality is relatively high with a gross NPL ratio of just 4.1%. Credit extended by banks in Sidoarjo, the area directly affected by the mudflow, represents a share of 20% of total credit to businesses located in East Java. Up to June 2006, credit quality in Sidoarjo exceeded the NPL indicative limit of 5%. As such, the hot mudflow in Sidoarjo is guaranteed to raise NPL in the area.

Worst Case Scenario
With the assumption that all credit extended by banks to Sidoarjo is non-performing, bank NPL will rise by Rp7.6 trillion. This in turn will raise gross bank NPL from 8.3% to 9.4%. Taken holistically, such a rise is relatively insignificant; however, when reviewed individually the gross NPL ratios of four banks are expected to exceed the industry average. The affected banks include two banks with central offices in East Java, one joint-venture bank and one state-owned bank. Initially, the NPL of the state-owned bank was below 6%, which indicates the rise in NPL is a consequence of unpaid mortgages. Additional provisions are required to offset the rise in gross NPL. With current year profits estimated to be insufficient, the difference has to be paid using capital. For other banks, increases in gross NPL ranged between 0.1% - 7.7%. Furthermore, the deficit in credit

Bank Credit Extension
The intermediation function in East Java is served by 67 banks with 932 offices. Nine banks have their central office located in East Java, spread out over 4 regencies and 1 municipality. In addition, citizens of East Java are also served by 338 rural banks. The majority of bank credit in East Java is extended to MSME with a market share of over 60% as per June 2006. MSME

provisions could be covered by current year profits. The banks have relatively high CAR, ergo; the impact of a rise in NPL would not affect capital. If the worst-case scenario outlined above transpires it could compound conditions of the three domestic banks. As a result, banks would have to withdraw their fund placement or limit their credit extension to the local banks, enabling the three aforementioned banks to meet

41

Chapter 4 Financial Sector

their liabilities. At the end of June 2006, each bank had sufficient placements at other banks and adequate SBI to cover inter-bank liabilities. Consequently, no interbank systemic risk would emerge. In conclusion, the mudflow incident is not expected to trigger short-term financial system instability. However, over the medium and long term, if the Lapindo incident is not resolved, contagion effects are expected

and need to be mitigated. This will raise operational costs in the business community, undermine the property sector, increase the NPL ratio for mortgages and cause the closure of numerous MSMEs as well as other small business centers. If this is allowed to occur, bank NPL will continue to rise and eventually adversely impact banks with central offices in East Java, especially small banks and rural banks.

Provisions
Despite the rising credit risk pressures, the net NPL ratio showed only a slight rise from 4.8% to 5.08%, due to ample provisions made by banks. Provisions commenced to show a rising tendency to confront the persistently high NPL ratio. This indicated that banks have strong resiliency in confronting the credit risk pressure, laying a solid ground for banks to sustained steady profitability and solid solvability.
Graph 4.17 Loans, NPL and Provision
Trillions of Rp 100 90 80 70 60 50 40 30 20 10 0 2000 NPL (lhs) Pr (lhs) Loans (rhs) 2001 2002 2003 2004 2005 2006 Trillions of Rp 800 700 600 500 400 300 200 100 0

(NCD) kept on rising, reaching 130.5% in May 2006. This was influenced by the greater rise in liquid instruments compared to the rise in short-term liabilities. The rather high increase in liquid instruments occurred on the deposit component of Bank Indonesia, specifically BI Certificates, which during some of the most recent auctions absorbed greater liquidity. This is in line with the high interest rate of low risk BI Certificates (SBI). Demand deposits at Bank Indonesia, including reserve requirement, increased in line with a rise in deposits. Liquidity in the banking sector increased reaching Rp1.163 trillion, with growth of 15.50% (y-o-y). Rupiah deposits showed a great increase, while foreign currency
Graph 4.18 Liquidity Ratio
Trillions of Rp 300
Liquid Assets (lhs) NCD (lhs) Liquid Assets/NCD (rhs)

% 131 121

260

111 101

220 91

Liquidity Risk
Up to the first semester of 2006 liquidity risk was dissipating and this was reflected by a rise in the ratio of liquid instruments held by banks. Since the beginning of 2006, the ratio of liquid instruments to non-core deposits

180

81 71

140 Des 2002

61 Jun 2004 Mar 2005 Dec Mar 2006 Jun

Notes: Liquid Assets consist of Cash, Demand Deposit at BI, CBI, and BI o/n Facility Non Core Deposits (NCD) consist of 30% Demand Deposits and Savings, and 10% Time Deposits of 1 - 3 months maturing.

42

Chapter 4 Financial Sector

Graph 4.19 Deposits
% 60 50 40 30 20 10 0
Demand Deposits Saving Times Deposits

Graph 4.21 Deposits Structure - Per Ownership
% 100 80 60 32.7%

40 20

57.5%

-10 -20 2004 2005 2006

0 Dec 2003 SOE Jun Oct 2004 Dec Jun Dec 2005 Feb Apr 2006 Jun

7.4%

Insurance

Pensiun Fund

Individual

Others

deposits decreased due to appreciation in the exchange rate of the rupiah against the US dollar. Rupiah deposits experienced a jump in demand deposits amounting to Rp20 trillion, near the end of the first semester of 2006. In addition, amidst lower public liquidity, the increase in banking liquidity, among others, was caused by the wealth effect of a bullish stock market and migration of government funds from the central bank. Furthermore, entrepreneurs tended to reallocate business funds to deposit temporarily, due to weaker purchasing power and rising interest rates. Although deposit insurance was limited, where since 22nd March 2006 the maximum deposit insured was set at Rp1 billion per depositor per bank, so far there have been no strong indications of substantial fund migrations from the perceived unsound
Graph 4.20 Deposit Structure
% 100 80 60 40 20

bank to the perceived safer banks or fragmentation of large savings into smaller ones. Deposits were less balanced with a concentration by 92% of short-term, up to 3 months. In addition, savings with a nominal value over Rp100 million with a share reaching 75.7%, controlled by only 2% of all accountholders. Such conditions indicate that banks liquidity is exposed to a potential risk of sudden substantial withdrawals by large accountholders. However, research results showed that 40%-60% of the deposits inclined to be over the medium term, both in the form of automatic roll over (ARO) and savings not withdrawn. This indicates that banking still forms the most important outlet for public funds investment and it proves that banking in Indonesia is still reasonably credible.
Graph 4.22 Deposit Structure - Per Nominal Amount
%

29.7 75.7 92.6 70.3 88.8

<100jt >100jt 24.3 11.2

7.4
0 2003 Demand Deposits 2004 Saving 2005 2006 Times Deposits
Demand Savings

Times Deposits

Total

43

Chapter 4 Financial Sector

Box 4.3

The Impact of Limited Insurance Scheme Implementation

Commencing September 22, 2005, the blanket guarantee scheme was phased out and replaced by a limited deposit insurance scheme provided by the Indonesian Deposit Insurance Corporation (IDIC). The phasing out is aimed at reducing budgetary burden to the state and eliminating moral hazard. On the basis of Law No 24/2004, IDIC has two functions: (1) to provide deposit insurance services; and (2) to undertake resolution of failure bank. IDIC insures demand deposits, savings, certificate of deposits, time deposits and all similar deposit items. To prevent unexpected negative consequences, the phasing out has been implemented in the following stages: September 22, 2005 √ March 21, 2006 - all deposits are insured. March 22, 2006 √ September 21, 2006 - deposits up to Rp5 billion are insured. September 22, 2006 √ March 21, 2007 - deposits up to Rp1 billion are insured. March 22, 2007 - onwards - deposits up to Rp100 million are insured per bank per customer. By providing insurance coverage of Rp100 million, the IDIC has insured 98% of assessed deposit accounts. This is due to the fact that the number of account less than Rp100 million is 98% of total customer accounts in banking sector. There are two potential negative consequences are identified in the lights of the commencement of limited insurance scheme: 1. Depositors will break their deposits account into smaller pieces of amount up to Rp100 billion.

2.

Migration risks, as depositors will tend to shift to the perceived sounder banks from the perceived less sound bank (switch to quality). Nevertheless, during the course of the first half

of 2006, the two above-mentioned problems appeared to be distant. First, deposits with nominal value of Rp15 billion grew rapidly, whilst on the other hand, those with nominal value of Rp100 million to Rp1 billion trended downward. Second, the share of high value accounts remained the same, stayed at 0.02% of total deposits held by banks. Finally, there was no switch to quality and fund migration from one to other bank. Based on bank daily reports, deposit base expansion occurred not only in the big banks, but also in small and medium size banks. Moreover, the medium size banks recorded a rapid growth of deposit base, whilst on the other hand, deposit base in foreign banks has been in a declining trend. Albeit these facts, Bank Indonesia has exercised strong vigilance to prevent the unexpected outcome of limited insurance scheme implementation, particularly to the liquidity risk exposure of banks. On the other side, banking customers may shift their portfolio away from banking products to speculative instruments, rendering financial system in a potential risk. These notions are based on the following rationales: a. The phasing out of blanket guarantee will continue up to March 22, 2007 with limited coverage of maximum Rp100 million per customer per bank. b. Refer to our banking confidence index survey, large depositors have exercised anticipative

44

Chapter 4 Financial Sector

measures by: (a) exercising extra prudent procedures in selecting banks; (b) placing deposits in only state-owned banks; (c) shift their portfolio in banks to other financial instruments or investing in non-financial assets.
Table Box 4.2.1 Account Distribution
(%)

A rise in deposits occurred not only in large banks but also in medium and small banks. The mediumsized banks showed the highest rise. On the other hand, deposits made at foreign banks are likely to decrease. Notwithstanding, the near-term effects of the limited deposit insurance scheme implementation on bank liquidity risk have to be tightly vigilance, considering the following factors: a. Limited deposit insurance coverage will continue to be phase in until 21st March 2007. However, thereafter all bank deposits up to Rp100 million per customer per bank are insured. b. Survey results indicated that some depositors, specifically corporations, are beginning to take various measures to anticipate limited deposit

Sep'05 Dec'05 Jan'06 Feb'06 Mar'06 Apr'06 May'06 Jun'06 < 100 jt 98.19 100 jt - 1 M 1.69 1 M - 5 M 0.11 >5M 0.02 98.10 1.77 0.11 0.02 98.10 1.77 0.11 0.02 98.14 1.73 0.11 0.02 98.17 1.69 0.11 0.02 97.96 1.88 0.13 0.02 98.00 1.84 0.14 0.02 98.04 1.80 0.13 0.02

Graph Box 4.2Ω.1 Deposits
Trillions of Rp Joint Venture 52.74 43.77 84.77 93.47 27.12 22.29 165.86 134.74 828.05 817.14 Dec '05 June '06

insurance coverage: (i) more than 50% of the respondents stated that they will be more selective in choosing banks, (ii) to save only in government banks or foreign banks, (iii) to reallocate the investment portfolio into other products in the financial sector and non-financial sector.

Foreign Small Medium Large Bank

Market Risk
Amidst high interest rates, banks had capacity to mitigate market risk, thus preventing instability in the banking system. Stress test results showed that the majority of banks were able to absorb market risk,-interest rates coupled with sharp depreciation of the rupiah-, as reflected by a stable CAR. In addition, interest rates of both bank credits and savings began to decline in June 2006 as an effect of the decline in the BI Rate. Furthermore, stronger rupiah did not lead to banking instability due to the ability of banks to better mitigate exchange rate risk. This was reflected by the relatively

controlled overall Net Open Position (NOP) at below maximum 20% threshold. Nevertheless, since the maturity profile of banks liabilities were generally in a short-term maturity gap, banks must remain vigilant of interest rates rise. This may incite more potential market
Table 4.1 Assumptions and Scenarios
Variable Decline in BI Rate Increase BI Rate Depreciation of IDR Volatality of IDR/US$ Scenario 100 - 500 bps 100 - 500 bps 1000 - 2500 poin 65%

45

Chapter 4 Financial Sector

risk pressure compared to the movements in exchange rate and government bonds price.
Table 4.2 CAR - BI Rate Increased Scenario
CAR Initial 18.55% 100 bp 18.00% 200 bp 17.45% 300 bp 16.89% 400 bp 16.34% 500 bp 15.79%

Table 4.4 CAR - IDR Depreciation Scenario
CAR Initial 500 bp 1000 bp 2000 bp 2500 bp 3000 bp 4000 bp 5000 bp

18.68% 18.67% 18.67% 18.66% 18.66% 18.66% 18.65% 18.64%

as rupiah depreciated by 5000 points. A well-controlled Net Open Position (NOP) - far below 20% - formed the backbone of strong banking capitalization to overcome

Stress tests are regularly conducted to measure the resilience of banks to market risk pressures, particularly to interest rate as well as exchange rate risks. The stress tests use the assumptions as in the table. Stress test results showed that, banks have sufficient resilience to absorb interest rate risk. With the sharp rise in the BI Rate reaching 500 bps, CAR experienced a decline but still remained above 8%. Such a condition is related to the structure of bank assets experiencing relatively modest market risk exposure. Besides, bank capitalization to cover market risk was relatively high. In addition, banks have sufficient spread to anticipate the possibility of drastic rises in domestic interest rates. Likewise, a dip in interest rates did not

exchange rate risk.

Profitability
Although credit risk pressure increased, the profitability of banks during the first semester of 2006 remained stable. Buoyant income in line with the persistently high interest rate, especially in credit, BI Certificates and government bonds, supported such a condition. The performance of banks is illustrated by the wide interest spread, reaching 4%, and the significant rise
Graph 4.23 Deposit - Lending Rate Spread
% 14 13 12 Working Capital Times Deposits 1 month Spread % 19 18 17 16 15 14 13 12 11 10 2003 2004 2005 2006

influence the rise of market risk faced by banks, but conversely, bolstered the structure of the earning assets of banks. Supporting by interest rates declining cycle, banks are well-capitalized and have capital structures that are more resilient to market risk as reflected by solid CAR. Confront to exchange rate risk, banking capital was sufficient to insulate the negative impacts. Based on the stress tests, large banks were resilient despite holding relatively larger foreign currency portfolios then other

11 10 9 8 7 6 5 4

Graph 4.24 NII and Certificate of Bank Indonesia Rate
% 8 7 6 % 20 18 16 14 12 10 8 6 CBI 1 month (rhs) NII (lhs) 2000 2001 2002 2003 2004 2005 2006 4 2 0

groups of banks. On average, banks CAR declined 3 bps
Table 4.3 CAR - BI Rate Declined Scenario
CAR Initial 18.55% 100 bp 19.11% 200 bp 19.66% 300 bp 20.21% 400 bp 20.77% 500 bp 21.32%

5 4 3 2 1 -

46

Chapter 4 Financial Sector

in net interest income (NII). Nevertheless, returns on assets (ROA) remained stable at 2.54% due to an increase in income as well as assets. The rise in credit risk pressure caused banks to form somewhat larger provisions triggering an increase in operational costs. This increase
50 100 % 7.8

Graph 4.26 Komposisi Pendapatan Bunga
6.9 6.8 8.4 8.9 9.8 9.5 9.2

75 56.4 59.7 63.2 63.2 63.1 59.7 59.3 59.2

in operational costs caused the banking efficiency ratio to decline. However, it significantly improved at the end of the semester. In the short term, the profitability of banks is estimated to improve, mainly due to a drop in the interest rate and a stable exchange rate. Nevertheless, the maximum performance of banks is determined by the capability of banks to manage the risk. The major challenge of banks is deteriorating credit quality, which raises NPL.
Graph 4.25 Cost Efficiency Ratio and ROA
% 140 120 100 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 ER (lhs) ROA (rhs) % 6 4
0 100 % 6.2 5.0 5.3 6.1 6.4 6.9 6.8 6.5 25 26.3 9.5 Jun 2004 BI 25.1 8.3 Dec 22.2 7.7 Mar 21.9 6.5 Sep 2005 22.0 6.0 Dec Loans 23.2 7.4 Mar 22.7 8.4 May 2006 Others 22.9 8.7 Jun

0

Securities

Graph 4.27 Revenue Structure of 15 Large Banks

75

53.0

56.8

61.1

61.3

61.5

58.5

58.1

58.4

50

25

32.7

31.4

27.5 6.1 Mar

27.8 4.8 Sep 2005

27.8 4.3 Dec Loans

29.7 4.9 Mar

29.2 6.0 May 2006 Others

29.0 6.2 Jun

8.0 Jun 2004

6.8 Dec BI

2 0 -2 -4 -6 -8

Securities

management. In general banks» capital is sufficient and capable of supporting credit growth as well as credit risk. However, several banks have marginal CAR exposed to vulnerable, mainly the threat of credit risk.

Capital
Banks was resilient to various risk pressures, supported by substantial capital. Improvement in profitability contributed solid CAR, reaching 20.5%. The greater part of the capital is core capital (Tier I) with a ratio of 17.9%, increased from the previous period 16.4%. In addition, banks capital improvement was also driven by a minimum capital of Rp80 billion as stated in the Indonesian Banking Architecture (IBA) program. This triggered an increasing core capital (Tier I) as well as CAR. In line with profitability prospects, the capital of banks will be determined primarily by the performance of risk

In the second semester, the resilience of banking system is forecast to improve in line with better macroeconomic condition. Intermediary function is expected to recover moderately as interest rate rigidity still exists. This is supported by positive business and consumer confidences. Declining interest rate cycle, packages of financial sector policy, investment climate and infrastructure are expected to boost the intermediary function of banks and promote credit quality. Bank credits will still concentrated in working capital, yet credits to corporate sector are expected to enhance selectively, especially in infrastructure. This is indicated by the commitment of

47

Chapter 4 Financial Sector

Graph 4.28 Capital Adeguay Ratio
% 28 26 24 22 20 18 16 14 12 10 2002 2003 2004 2005 2006 CAR

Bureau and the refinement of the Debtor Information System will lessen potential credit risk from new debtor. Nonetheless, NPL will only occur in areas stricken by disasters, such as the earthquake in Yogyakarta, hot mud flooding in East Java and the tsunami on the south coast of Java. This is projected to have insignificant impacts on banking stability. NPL improvement is supported by an augmentation of corporate income and stronger purchasing power in line with the declining inflation and interest rates. Bank liquidity is estimated to rise despite the commencement of limited deposit insurance

banks to provide funds to the amount of Rp100 trillion to infrastructure development. Credit risk pressure will alleviate in line with the macroeconomic improvement that buttress better NPL. In addition, NPL resolution of two large banks, which is nearly complete, will also reduce NPL significantly. Moreover, the establishment of the Credit Information
Graph 4.29 Tier 1 to Risk Weighted Asset (June 2006)
% 30.0 25.0 20.0 15.0 10.0 5.0 0.0 A B C D E F G H I J K L Bank M N O 15LB Foreign JV Others Indst Average CAR Tier 1 : RWA

implementation beginning in March 2007. It is estimated that banks will remain the prime outlet option for public investment funds, considering limited public knowledge in financial market investment.
Graph 4.30 CAR as of Bank Peer
% 26 25 24 23 22 21 20 19 18 17 16 15 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun 2006 2005
Large Bank Other Bank Industry average

48

Chapter 4 Financial Sector

Box 4.4

Credit Information Bureau and Debtor Information System

The establishment of Credit Information Bureau (CIB) is one of initiatives under the auspices of the 5th pillar of Indonesian Banking Architecture (IBA), which is aimed at building robust infrastructure for banking and financial sector. Furthermore, the objectives of CIB development is also to improve the efficiency of bank and non bank financial institutions» financing and risk management via the availability of quality debtor information system. Prior to CIB, Bank Indonesia had established Credit Information System (CIS) and developed as Information System of Funding Provision (ISFD). The units had relatively the same tasks as existing CIB. Since 2005, the system has been improved into the Debtor Information System (DIS), which provides comprehensive information of individual debtors. The DIS is ultimately aimed at eliminating information asymmetry. It enhances effectiveness of banking intermediation by reducing potential credit risk exposures as lenders have information of creditworthiness of their potential debtors in advance, a conditions leading to the stability banking sector in the long-term. The DIS has the following features: a. The scope of reporting institutions includes commercial banks, rural banks, Islamic rural banks, non-bank credit card issuers, and non-bank financial institutions. Reporting is mandatory for all banks with total assets of more than Rp10 billion and voluntary for non-banks. b. The report includes all financing by reporting institutions, starting from Rp1. c. The monthly reports should be submitted on line via a web-based system to Bank Indonesia.

d.

Sanctions will be applied to those not submitting the reports and delay submissions.

e.

Reporting institutions fully complying with terms and conditions set in advance are granted access to the real-time and on line Individual Debtor Information (IDI). The coverage of IDI includes information of debtor identity, ownership, shareholders, loans granted by other banks, outstanding amount, collateral, and credit quality. The information is beneficial for banks as the basis for their credit analysis processes. The establishment of CID and DIS has the

following benefits: For Lenders: Minimize asymmetric information problem. It helps to expedite the process of credit analysis and approval, including mitigation of adverse selection. Comprehensive and accurate information in DIS buttresses effective risk management. Therefore, banks have more capacity to prevent and alleviate non-performing loans. Reduce dependency on conventional collateral scheme in financing. Lenders will be stimulated to assess creditworthiness and reputation of debtors as one of the main factors for credit approval. For Debtors: Speed up credit approval New debtors will likely to enjoy wider access to financing as their credit reference and creditworthiness are disclosed to all banks and other financial institutions.

49

Chapter 4 Financial Sector

NON BANK FINANCIAL INSTITUTIONS Multi-finance Companies
Stability of the multi-finance industry was maintained amid upward credit risk and a restrained source of funds.
Conditions in banking sector during the reporting period spilled over to the multi-finance industry. Bank financing, the main source of funds for multi-finance companies, was restricted in the reporting period. This decelerated financing expansion despite upbeat business prospects. As a result, during the first quarter of 2006 the business volume of multi-finance companies declined significantly but rebounded by the end of semester I-2006. Along with the slowdown in economic activities and consumer purchasing power, risk exposure to multi-finance companies increased slightly but remained controllable. The profitability of multi-finance companies declined in early 2006, however it rebounded gradually. Nevertheless, fresh capital injection strengthened the solvency of such companies.

persistent upward risk pressures, indicated by an increase in provisioning for financing losses. However, risk measurement of multi-finance companies seemed to be more lenient than of banking institutions, resulting in a biased risk profile. Nevertheless, the establishment of the Credit Information Bureau to facilitate the debtor information system including multi-finance companies, will reduce asymmetric information. Therefore, the ability multifinance companies to mitigate credit risk will significantly improve. The vast majority of consumption financing is for automobile financing, which offers more attractive rates and procedures than those offered by banks. This is possible as several multi-finance companies are affiliated with the automotive industry. Such affiliation has empowered finance companies to facilitate and provide affordable financing for customers. In addition, the domestic market for vehicles, particularly motorcycles, has shown bright prospects. Fuel price hikes were the primary factor encouraging the shift towards motorcycles as the main means of transportation for

Business Volume
Multi-finance companies are increasingly playing a greater role in the Indonesian financial sector. The business activities of these companies have expanded; reflected by an increasing volume of financing equivalent to 10% of total credit allocated by banks. During the reporting period, business activities decreased in early 2006 but rebounded by the end of semester I 2006. Consumer financing rebounded whilst other types of financing slowed. Credit card financing, on the other hand, plummeted in line with the upward trend of NPL. This was the result of a drop in repayment capacity commensurate with inflationary pressures and a rising cost of living. With the exception of consumer financing, the slowdown in business activities was accompanied by

low to middle income earners. Furthermore, the historical performance of consumption financing has been positive with lower NPL resulting in a more manageable credit risk profile. Therefore, demand for this segment is still prospective.
Graph 4.31 Financial Structure of Multifinance Companies
Trillions of Rp 50 45 40 35 30 25 20 15 10 5 0 2000 2001 2002 2003 2004 2005 2006 Leasing Consumer Payment Factoring Credit Card

50

Chapter 4 Financial Sector

Graph 4.32 Securities and Loan Loss Provisions
Trillions of Rp 6 5 4 3 2 1 0 2000 2001 2002 2003 2004 2005 2006 Provisioning Securities

East Indonesia. However, high dependency on bank financing might trigger contagion risk in the banking system. Conversely, systemic banking crisis will directly impact multi-finance companies. Compared to banks, financing allocated by multi-finance companies was relatively small, totaling 3%. Alternative sources of funding for multi-finance companies originated from the non-bank financial system, including bonds issuance. The use of bonds as an alternative source of funding began in 2002. Bonds

Moreover, investment in securities by multi-finance companies increased significantly, including BI certificates and government bonds. This development warranted vigilance as finance companies preferred to shift from their intermediary function to invest in financial markets.

represent an alternative source of funding amidst constraints to bank credit. The majority of multi-finance companies listed in the capital markets are those affiliated with the automotive industry, which is driven by the strategy to maintain sustainable vehicle production as well as meet high demand. All bonds issued in semester I 2006

Source of Funds
Finance companies accumulated balanced funding from domestic and offshore sources with the vast majority stemming from banks (67%). With hikes in domestic lending rates, funding from banks plummeted. In addition, banks undertook credit rationing to finance companies, meanwhile, offshore funding dried up. This undermined financing in some market segments, however, leasing for heavy equipment and consumption financing remained prospective. Soaring demand for coal as an alternative source of energy boosted leasing activities, especially in
Graph 4.33 Source of Funds
Trillions of Rp 60 50 40 30 20 Bank Loans Non Bank Loans Subordinated Debt Bond Issurance

were by multi-finance companies, totaling Rp3.67 trillion. These included Summit Oto Finance I, Federal International Finance VI, Perum Pegadaian XI, Adira Dinamika MF II and WOM Finance III. Despite the interest rate hikes in 2005, multi-finance companies continued to issue bonds due to prospective business, particularly in leasing and consumption financing. Multi-finance companies posted a moderate level of leverage, reflected by a falling debt to total asset ratio from 0.76 to 0.74. However, the ratio of debt to financing was 1.07, indicating the dominance of credit. This indicated
Graph 4.34 Funding Structure
Trillions of Rp 35 On shore 30 25 20 15 10 Off shore

10 0 2000 2001 2002 2003 2004 2005 2006

5 0 2000

2001

2002

2003

2004

2005

2006

51

Chapter 4 Financial Sector

Graph 4.35 Debt/Assets, and Debt/Financing Ratios
1.4 1.2 1 0.8 0.6 0.4 0.2 0 2000 Debt/Financing Debt/Assets 2001 2002 2003 2004 2005 2006

17.60% (December 2005). Relevant indicators reflected sufficient ability of multi-finance companies to mitigate increasing financing risks. Persistent high demand for consumption financing is expected to drive the expansion of multi-finance companies. In addition, relatively attractive investment financing through capital goods leasing provided generous opportunities for business expansion. Moreover, multifinance companies are likely to issue bonds and raise offshore funds, as banks delayed cutting their lending rates

that the intermediary function of multi-finance companies exceeded banks. Consequently, multi-finance companies will demand significant amounts of funding. Nevertheless, constraints to bank credit temporarily discouraged the expansion of multi-finance companies.

in 2006. Consumer purchasing power will not recover significantly due to low expected economic growth in the second semester of 2006. Consequently, growth in consumption financing will remain limited but prospective. Financing segments that remained promising include motorcycle financing and leasing in the mining

Profitability and Solvency
Along with the decline in business volume and mounting credit risk, the profitability of multi-finance companies declined slightly at the beginning of 2006, but rebounded gradually in the subsequent period due to seasonal factors. This was reflected by the return on assets (ROA), which achieved 1.4% and the return on equity (ROE) of 10.2%. Furthermore, this boosted the ratio of capital to total assets from 12.30% (December 2005) to 13.96% (June 2006), whereas the ratio of capital to financing also increased; to 20.00% (June 2006) from
Graph 4.36 Capital/Financing
% 30 25 20 15 10 5 0 2000 CAR Capital/Financing 2001 2002 2003 2004 2005 2006

sector. However, all multi-finance companies must become more vigilant in expanding their consumption financing portfolio to offset the probability of default. Regulations targeting multi-finance companies, namely strengthening capital structure, enhancing regulatory quality, supervision and examination, are expected to improve the prudence, performance and soundness of multi-finance companies significantly.

CAPITAL MARKET Equity Market
The Jakarta Composite Index skyrocketed due to transactions dominated by foreign investors. Although the equity market faced slight pressures by the end of semester I 2006, generally, conditions remained stable.
Foreign investors dominated buying rallies in the equity market and this boosted stock prices expeditiously. Notwithstanding, the bullish rallies were neither driven by fundamental factors nor the performance of issuers. This

52

Chapter 4 Financial Sector

could indicate a price bubble in the equity market. The rallies, however, were cut short by the Fed Fund Rate hike, albeit insufficient to trigger a crash. Prevailing positive sentiment surrounding yield in the domestic markets prevented unexpected selling by foreign investors and subsequent capital outflows. In terms of new issuances, constraints to banking credit, triggered by interest rate hikes stimulated corporations to raise funds from the equity market. The nominal value of initial public offerings (IPO) in semester I rose significantly over the previous semester. The equity market is expected to remain bullish, albeit its pace slower than the previous period. This is supported by improvements in macroeconomic indicators, a higher sovereign rating and soaring international commodity prices, as well as prospective business opportunities in terms of infrastructure and alternative energy sources.
10,000 5,000 -

Graph 4.38 Foreign Investors Transactions
Billions of Rp 1,600 1,400

1,200 (5,000) 1,000 (10,000) (15,000) (20,000) Net Foreign (lhs) JCI (rhs) Jan Feb MarApr May Jun Jul AugSep Oct Nov Dec Jan Feb MarApr MayJun 2005 2006 800 600

Source : Bloomberg

Furthermore, the improved sovereign rating of Indonesia and buoyant global commodity prices also contributed to the rallies. Political instability in the Philippines and Thailand benefited the Indonesian equity market as foreign investors redirected their portfolio. On the other hand, positive sentiment stemmed from better inflation expectations for 2006 and the postponed hike in the basic electricity tariff.

Equity Market Performance
The equity market enjoyed bullish rallies, however, corrections occurred at the end of semester I 2006. This was evidenced by a significant jump in the Jakarta Composite Index (JCI) during the first five months of the semester, posting its highest level in history: 1,553.06 (May 2006) from 1,122.37 (December 2005). Foreign investor transactions and regional factors in emerging market countries supported the bullishness of the equity market.
Graph 4.37 Jakarta Composite Index and Volume of Shares
Volume Shares-Millions 1,600 Volume (rhs) 1,400 JCI (lhs) 5,000 4,500 4,000 3,500 1,200 1,000 3,000 2,500 2,000 800 600 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun 2005 2006 1,500 1,000 500

Over optimistic investors dramatically boosted share prices and related indices, which was also supported by the herding behavior of local investors. Real sector and corporate fundamentals are yet to signal significant strengthening, which can indicate a price bubble. However, the rallies mentioned strengthened the rupiah exchange rate by 11.46% and improved forex reserves. At the beginning of the semester, domestic and global interest rate expectations were positive attributable to a peak in the Fed Fund Rate Cycle at 5%. Nevertheless, expectations reversed subsequent to the Fed continuing its rising cycle; a condition that spurred expectations of a persistent Fed Fund Rate rise. This sparked a capital reversal from emerging markets, including Indonesia. As a result, the JCI plunged by 10% within a week, proving the existence of a price bubble. Violent fluctuations in the JCI were evidenced by relatively high volatility, peaking in May 2006 at 2%; surpassing average volatility during the first semester at 0.87%.

Source : Bloomberg

53

Chapter 4 Financial Sector

Graph 4.39 Volatility of JCI
40 35 30 25 20 15 10 5 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source : Bloomberg (y = 509.23e-0.0013x))

I 2006, reaching record levels in May at Rp61.11 trillion before nose-diving to Rp29.08 trillion in June 2006.
1600

The rush for blue chip shares in certain sectors, new IPO and rights issues drove significant market capitalization. In semester I 2006, six new initial public offerings emerged by Bakrie Telcom (Rp605 billion), Malindo Feedmill (Rp53.68 billion), Okansa Persada (Rp9.35 billion), Bank Bumi Artha (Rp5.4 trillion), Bank Bukopin (Rp295.32 billion), and PT Radiant Utama Interinsco (Rp42.50 billion). The new IPOs totaled Rp6,38 trillion, exceeding the

VJSX (lhs) JCI (rhs) Expon. (JCI (rhs))

1400 1200 1000 800 600 400 200 0

Indonesia remained on the list of pension funds of the California Public Employee Retirement System (Calpers). This fostered positive sentiment regarding investment in the Indonesian equity market, amid inauspicious global interest rates. Furthermore, positive signals of the falling BI rate cycle, beginning in May 2006, helped stabilize the market and stimulate transactions despite a Fed Fund Rate hike to 5.25% (June 29, 2006). At the end of semester I 2006, the index closed at 1,301.26, an increase of 147.63 bps (12.70%) over the end of 2005. The bullish equity market augmented market capitalization, which reached its highest ever level of Rp1,004 trillion in April 2006, despite a subsequent drop to Rp901 trillion as a result of market risk pressures. A dramatic rise in transaction value was witnessed in semester
Graph 4.40 JCI and Market Capitalization
Billions of Rp 1,100,000 1,000,000 Capitalization (lhs) JCI (rhs) 1,600 1,400

previous year of Rp3.50 trillion. Listings by banks were sound and stemmed from the business plan to meet the capital adequacy requirement in Indonesian Banking Architecture. Several sectors dominated market capitalization, including mining, agriculture, infrastructure, finance and retail. The persistent trend of high commodity prices in global markets, including natural gas, gold and coal, drove high-return expectations in these sectors. Bullishness in the mining sector raised the mining index by 20.69%. Bullish market sentiment contributed to share trading in the mining sector, including the merger between Bumi Resources and Energi Mega Persada. Furthermore, share selling by Bumi Resources provided significant capital inflows to Indonesian markets. In addition, the resolution of the dispute between Pertamina and Exxon Mobile over
Graph 4.41 Foreign Investors Trading
80,000 70,000 60,000 50,000 Volume - (lhs) Trading Value (Billion Rp) - (lhs) JCI (rhs) 1,600

1,400 1,200

900,000 800,000 700,000

1,200 1,000 800

40,000 30,000 20,000 10,000 Jan Feb MarApr May Jun Jun Aug Sep Oct Nov Dec Jan Feb MarApr MayJun 2005 2006 600 1,000

800

600,000

Jan Feb MarApr MayJun Jun Aug Sep Oct Nov Dec Jan Feb MarApr MayJun 2005 2006

600

Sources : CEIC and Bloomberg

Sources : CEIC and Bloomberg

54

Chapter 4 Financial Sector

the Cepu Exploration Block sparked positive sentiment concerning mining sector shares. In addition, initiatives to explore alternative sources of energy were the main driving factor for investors to shift their portfolio to the agricultural sector. Unrelenting high crude palm oil prices in global markets induced buying rallies of agribusiness shares and, raised the index dramatically by 34.01% on average. This was predominantly supported by the soaring share price of plantations. The telecommunications sector also remained buoyant with companies like PT Telkom (the largest telecommunications company in Indonesia), among others, successfully maintaining their blue chip position. High demand and positive growth in the telecommunications industry reflected the bright prospects of this sector and, consequently, drove investors to take long positions. The financial sector remained the target of portfolio diversification, however, its shares no longer dominated shifts in the composite index. Uncertainty surrounding the impact of interest rate and foreign exchange risks encouraged investors to become more prudent when investing in financial sector shares, and lead to a slowdown in market capitalization. Soaring interest rates adversely impacted the asset quality and profitability of banks as well as limiting their intermediation function. However, strong investor appetite for banking shares remained due
Graph 4.42 Sectoral Index and JCI
1,600 1,400 1,200 1,000 800 600 400 200 Jan Feb Mar Apr May Jun Jun Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun 2005 2006
Source : Bloomberg

to robust fundamentals and attractive gains. In addition, the shares were awarded a higher rating, which attracted investors to take long positions. The equity market is expected to remain bullish attributable to improved macroeconomic indicators including lower inflation and interest rates, a stronger balance of payments (BoP) as well as a higher sovereign rating. Confidence in the Indonesian economy has grown; therefore, expectations regarding near-term gains will remain positive. Foreign investors are expected to dominate transactions until year end. Nevertheless, all authorities must become more vigilant in terms of capital reversal risks. In addition, the Fed Fund and BI rates, global commodity prices and country risks will remain the drivers of price movements in the near future. Initiatives to deepen capital markets, including the merger of the Jakarta Stock Exchange and Surabaya Stock Exchange, remote trading, refining regulations and ereporting, e-licensing, e-registration and e-monitoring, are expected to attract more investors. To enhance the capital market as a source of funds for real activities, IPO procedures for new listings will be simplified. Among others, key regulatory relaxation includes tax relief for new listings in the equity markets. In future, initial public offerings are expected to increase significantly commensurate with the improved economy and better performance of the corporate sector.

MUTUAL FUNDS
JCI Agriculture Infrastructure Consumption Mining Various Industries

Mutual funds were stable and innovation supported industry recovery
The mutual funds industry regained momentum subsequent to a collapse in 2005. The rebound was attributable to a variety of product innovations and improvements to regulations in the market, as well as more proficient investment managers in terms of

55

Chapter 4 Financial Sector

diversifying mutual funds products. Through innovation and diversification, investors have the freedom to invest in mutual funds that correspond to their desired level of risk. In addition, the outlook for mutual funds remains positive and is expected improve further due to falling interest rates.

Initiatives to develop mutual funds were implemented through the innovation of structured mutual funds. Product development was targeted at expanding the investor base and attracting risk averse investors. There are two types of structured mutual funds: (1) protected mutual funds launched in October 2005; and (2) indexed mutual funds launched in early 2006. Initially, structured

Performance of Mutual Funds
The mutual funds market began to recover due to higher asset prices, particularly bond prices. The recovery was principally supported by the improved capacity of investment managers to develop and innovate products. The performance of mutual funds expanded the investor base to meet specific investor requirements (tailor-made). In addition, improved regulations in the mutual funds market restored investor confidence and bolstered market recovery. The recovery was evidenced by the increasing net asset value (NAV) and fewer redemptions. The NAV of mutual funds rose slightly from Rp28 trillion (December 2005) to Rp33 trillion (June 2006), whereas redemptions fell from Rp5 trillion (December 2005) to Rp4 trillion (June 2006). Subscriptions jumped to Rp5 trillion (June 2006) from Rp3 trillion (December 2005). When subscriptions exceed redemptions, it indicates restored investor confidence in mutual funds.
Graph 4.43 Mutual Fund and Net Asset Values
Trillions of Rp 35.00 Redemption 30.00 25.00 Subscription NAV

mutual funds were unsuccessful in attracting investors, however, since 2006 investment increased significantly pushing up NAV by 111% to a 21% market share. In addition, indexed mutual funds were launched at the beginning of 2006 comprising of asset prices which form the benchmark index. The perceived lower risk of mutual funds was key to their high demand, however, since mutual funds are new to domestic investors their net asset value remained low at Rp 13 billion. The performance of conventional mutual funds remained positive along with recovery in the bonds market. High volatility in the equity market exacerbated the drop in equity and mixed mutual funds. During the previous year, investors limited their portfolio of this type of funds despite high potential returns. Moreover, persistently high interest rates supported the performance of money market mutual funds. Amid uncertainty surrounding interest rates, investors preferred to invest in money market mutual funds, which provide flexibility without penalties.
Graph 4.44 Type of Mutual Funds
Trillions of Rp

16 Fixed Inc 14 12 10 Shares Mixed Money Market Protected

20.00 15.00 10.00 5.00 0.00 Sep Oct Nov 2005 Dec Jan Feb Mar Apr 2006 May Jun

8 6 4 2 0
Des 2005 Jan Feb Mar Apr May Jun

2006

56

Chapter 4 Financial Sector

The rebound in NAV is projected to continue and mutual funds are expected to stabilize. This is attributable to the following: Continuous product innovation by investment managers to develop structured mutual funds, consisting of protected and indexed type. In addition, innovation will also include the money market and mixed mutual funds. Regulations requiring specific qualifications of investment managers. The regulations will positively impact the quality of investment managers and also enhance accountability as well as supervisor quality through regulation refinement for marketing and security agents. The prospects of an interest rate drop indicated by a decline in the benchmark BI Rate beginning in May 2006. This may trigger upbeat behavior in terms of shifting from time deposits to mutual funds. Such conducive conditions are expected to gradually rebuild investor confidence leading to a more robust mutual funds market. In addition, product development and innovation encourage investors to diversify risks based on their risk appetite.

and declining interest rates. Indonesian Retail Government Bonds (ORI) are expected to boost the intermediary function of the bonds market. In concurrence with expected economic recovery and better corporate performance, corporate bonds will increase in the near-term.
Graph 4.45 Bond Prices - Selected Series
120 115 110 105 100 95 90 85 80 75 70
29 Dec 12 Jan 26 Jan 9 Feb 23 9 23 Feb Mar Mar 6 Apr 20 4 18 1 Apr May May Jun 15 Jun 29 Jun

FR0002 FR0023

FR0005 FR0025

FR0019 FR0027

FR0020 FR0029

2005
Source: Surabaya Stock Exchange

2006

Government Bonds
The government bonds market rebounded, reflected by the rise in transactions and prices, which had previously fallen due to interest rates hikes. Nevertheless, foreign investors and banks dominated transactions with positive expectations for future prices. Uncertainty regarding the increasing global interest rate cycle encouraged investors

BONDS MARKET
The government bonds market remained buoyant attributable to active foreign investor transactions. However, the corporate bonds market appeared to be stagnant.
Despite slight pressures, the bonds market - particularly government bonds - remained attractive, dominated by foreign investors. Attractive gains in the government bonds market stimulated foreign investment and raised their portfolio in Indonesian bonds. The outlook for the bonds market is positive in line with the improving macroeconomic indicators, including fiscal conditions, the sovereign rating

to adjust their portfolio. This created downward pressure on bond prices in May 2006 leading to higher volatility by
Graph 4.46 Yield Spread of Selected Asian Countries
% 7 6 5 4 3 2 1 0 -1 -2 1yr 2yr 3yr 4yr 5yr 6yr 7yr 8yr 9yr 10yr 15yr Source: Bloomberg, process INDON PHIL INDIA THAI

57

Chapter 4 Financial Sector

Graph 4.47 Government Securities Yield Curve
% 18 16 14 12 10 8 6 4 2 0 2004
Source: Surabaya Stock Exchange

which supported market recovery and contributed to rupiah appreciation.

Corporate Bonds
High yield in the corporate bands market also drove investors towards corporate bonds. In addition to domestic investors, foreign investors also showed interests
1 yr 2005 3 yr 10 yr 2006

in selected bonds. Foreign investors accounted for 71.8% of total corporate bonds, predominantly investment grade bonds (AAA to A-). However, the vast majority of the high-rated corporate bond investors were pension funds whose total share of portfolio accounted for 28% and are likely to hold bonds as their medium-term investment outlet. Consequently, the corporate bonds market was less liquid and active compared to the government bonds market.
Graph 4.49 Corporate Bond
BBB2.6%

the end of semester I 2006. Market conditions, coupled with uncertainty surrounding the future prospects of interest rates, were more attractive for short-term investors. Exacerbated by non-transparent benchmark pricing, investors compounded price volatility. Rising global interest and Fed Fund rates following FOMC on June 29, 2006 impinged upon the transmission effects of domestic interest rate cuts. Against this backdrop, investment yield in rupiah in various maturity bands temporarily declined by 120-140 bps, however, this quickly rebounded by 15-20 bps in the second quarter of 2006. As a result, yield in rupiah was higher compared to neighboring countries like Thailand, the Philippines and India. Attractive yield drove investors towards government bonds, increasing the portfolio share held by foreign investors from 8% (December 2005) to 12% (June 2006),
Graph 4.48 Ownership of Government Bond
Billions of Rp 60000 Citibank 50000 40000 30000 20000 10000 0 Dec 2005 Jan Feb Mar 2006 Apr May Jun Deutsche HSBC Stanchart Total

BBB+ 7.2% A20.6%

BBB 7.0%

B0.1%

D/SD 10.7% Not Rated 0.6% AAA 3.2% AA 5.5% AA6.8% AA+ 11.5%

A 9.8% A+ 14.5%
Source: Surabaya Stock Exchange

Graph 4.50 Corporate Bond Holders
Individual-Domestic 1.25% Institution-Domestic- Others 0.50% Cooperative Mutual Fund 0.03% 19.09%

Foundation Taspen 2.35% Jamsostek 2.86% 5.60%

Broker 1.25%

Incorporation 7.65%

Insurance 9.78%

Bank 21.65%

Pension Fund 28.00%

Source: Surabaya stock exchange

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Banks and multi-finance companies remained the largest group of corporate bond issuers, particularly those allocating consumption financing. Compared to the previous year, the issuance of corporate bonds in semester I 2006 was sluggish due to high interest rates and uncertainty. Notwithstanding, pricing was non-transparent constricting liquidity and activity. The stagnant corporate bonds market was indicated by the falling transaction value, which during the course of semester I was Rp7 trillion. The amount of bonds issued totaled Rp3.67 trillion stemming from high demand for consumption financing and the constraints in bank funding. Infrastructure companies ranked second in terms of issuing bonds, totaling Rp1.20 trillion during semester I 2006. As a result, total corporate bonds issued during the first semester totaled Rp4.87 trillion. These were issued by Summit Oto Finance I, Federal International Finance VI, Perum Pegadaian XI, Adira Dinamika MF II, WOM Finance III, PLN VIII, PLN Sharia Ijaroh I and Jasa Marga XII The near-term stability of the government bonds market appears to be positive due to falling domestic

interest rates. In addition, a higher sovereign rating, better fiscal performance and the issuance of retail government bonds (ORI) will contribute to higher transactions in the bonds market. ORI, which will be issued amounting to Rp2 trillion, has been oversubscribed. In addition, foreign investors remain upbeat regarding the prospects of government bonds and, therefore, they will remain dominant. Foreign investor expectations of attractive capital gains will encourage investors to play a significant role in the domestic market. The hitherto continuous Fed Fund Rate rising cycle appears to have been suspended, which contributes to the positive outlook for government bonds. The corporate bonds market is expected to rebound in line with declining interest rates, brighter prospects and positive business expectations. New issuers in the capital market will be dominated by banking institutions to meet their capital adequacy requirement. Furthermore, the relatively constrained intermediary function of banks will stimulate intermediation in the capital market though the issuance of bonds. This will be supported by a buoyant economy and improved corporate performance.

Graph 4.51 Issuer Profile
Finance 48,98% Finance (Mult, Fin) 18,69% Mining 1,22% Consumer Goods Industry 3,67%

Consequently, demand for investment and expansion is forecast to increase. The bonds market is predicted to become more robust in accordance with better macroeconomic fundamentals and falling interest rates. Additionally,
Miscellaneous Industry 2,45% Infrastruc,Utilities & Transportation 22,26% Trade, Service & Investment 6,94%

foreign investors will become more active. Furthermore, relatively restrained bank financing will foster active financing from the bonds market via a longer-term financing structure.

Basic Industry and Chemicals 10,20%

Agriculture 5,71%

Source: Surabaya stock exchange

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Chapter 5 Financial Infrastructure

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Chapter 5 Financial Infrastructure

More robust financial infrastructure amidst increasing settlements

PAYMENT SYSTEM
Supported by the effective implementation of the National Clearing System, the payment system has become more robust. Risks, on the other hand, are well-mitigated by Business Continuity Plan. Increasing volume and transactions indicated the resilience of payment system as settlement risk was alleviated. This contributed stability in the financial system, among others through the implementation of Failure to Settlement Arrangement mechanism. This mechanism requires a mandatory prefund by banks in clearing system. Furthermore, Bank Indonesia continuously enhances regulation related to card based payment to lessen credit risk and potential loss of issuers. As per type of sender, Bank Indonesia, whose nominal value of transactions accounted for 39.7% of the total at BI-RTGS, was the largest. Bank Indonesia transactions included monetary operations, payments
Thousand 800 700 600 500 400 300 200 100 0 2000 2001 2002 2003 2004 500 Volume 2005 Nominal 0 2006 2,000 1,500 1,000

Graph 5.1 RTGS Settlements
Trillions of Rp 3,000 2,500

Development of Payment System RTGS and Clearing
Settlements through BI RTGS continued to grow with average daily transactions of Rp105 trillion (USD 11.5 billion), an annual increase of 22% (y-o-y). Bank customers accounted for 76% of total transactions, whereas per transaction purpose, the largest was for monetary contraction (Bank Indonesia IDR intervention) which accounted for 19% of total transactions.

related to government bonds, taxation booking, and disbursement of the government»s budget. As per frequency, commercial banks were the most active players, as they accounted for 21.7% of total transaction frequency. These banks used bulk transactions for domestic currency transfers, the inter-bank money market and foreign exchange transfers. The trend in transaction volume growth reflected stronger pubic confidence in security and the versatility of

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Graph 5.2 RTGS Players
% 50 45 40 35 30 25 20 15 10 5 0
Foreign Banks 9.64 4.94 3.62 Bank Indonesia 15.96 23.65 20.96 13.19 10.66 3.63 5.33 0.03 0.21 Joint Venture State-Owned Banks Banks Regional Banks Domestic Non Banks Private Banks 46.90

payment system, the failure to settle arrangement to eliminate systemic failure has been effectively implemented. This scheme requires clearing participants to use a pre-fund and has helped mitigate risks in the payment system.

Nominal Share Volume Share

41.30

CARD-BASED PAYMENTS
Card-based payments have continuously followed an upward trend. The use of ATM (automated teller machine), credit and debit cards were 85,4%, 10,4% and 4,1% respectively. However, by nominal value, ATM card were 93,8%, whereas credit cards and debit cards were 4,5% and 1,7% respectively. These figures indicate a shift in public preference from cash-based payments towards card-based payments (cashless society). Spike in the ATM and debit card transactions at the end of 2005, revealed higher cost of living due to soaring oil price hikes. In addition, the use of credit cards remained far below the other means of payment, as the public take the high interest rates of credit cards into major consideration. To this extent, Bank Indonesia has been vigilant over credit card performance. This is due to the growing number of non-performing loans of credit cards that have slightly exceeded 10%. To limit the probability of credit card default, Bank Indonesia has announced a minimum payment of 10%, by December 2005.
Graph 5.4 Value of ATM, Credit and Debit Cards Transactions
Trillions of Rp 160 140 120 100 80 60 40

the BI-RTGS system. Notwithstanding, it is fairly hasty to conclude that the trend indicated rapid economic growth, as a substantial fraction of settlements were financial sector transactions. On the other hand, settlements directly related to the real economy remained lower than the financial sector. Thus, the growing trend of large value transactions did not reflect growth of the real economy. Retail payment system showed a downward trend. Unlike the large value payment system, the retail payments system through clearing dropped by 18.22% (y-o-y). Shifts to BI-RTGS have become the major factor behind the downward trend in the retail payment system. As per clearing region, Jakarta clearing area accounted for 48% of total settlements with a nominal value of half. This reflected that economic activities remained centralized in Jakarta and the surrounding areas. Bank Indonesia is strongly committed to promote a robust payment system. To mitigate the risks in the
Graph 5.3 Clearing Settlements
Million 10 9 8 7 6 5 4 3 2 1 2002 2003 2004 2005 2006 Volume (lhs) Nominal value (rhs) 20 -

Billions of Rp 200,000 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 2000 2001 2002 2003 2004 2005 2006 Credit Debit ATM

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Graph 5.5 Volume of ATM, Credit and Debit Cards Transactions
Millions of Transaction 80 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 Credit Debit ATM

tests on the backup of both payment systems are regularly exercised. Besides, Bank Indonesia examines the backup infrastructure at the Disaster Recovery Center on a monthly basis. The preparedness of the backup system supports the availability of BI-RTGS and the National Clearing System against all potential disruptions, including natural disasters and operational failures. In order to enhance legislation as well as security and efficiency in payment system operations, Bank Indonesia has enhanced the legal apparatus of the payment system complying with international standards and best

Keterangan : Penyesuaian pengklasifikasian pada triwulan IV 2005

PAYMENT SYSTEM DEVELOPMENT
Since the successful implementation of the Jakarta National Clearing System in July 2005, Bank Indonesia has gradually commenced operating the National Clearing System (SKNBI) in the other provinces of Indonesia. Bank Indonesia has set the target for the BI-National Clearing System to be implemented in at least 52 clearing regions in Indonesia by the end of 2006. Indonesia will have a more efficient domestic clearing system once the BINational Clearing System has been fully implemented and integrated. Consequently, the clearing process will be faster, safer, and more effective, therefore, supporting economy activities. To mitigate risks in the payment system, Bank Indonesia has prepared a disaster recovery plan for the payment system that is critically important, predominantly in the BI-National Clearing System and BI-RTGS. Trials and

practices. Additionally, in efforts to enhance legislation in inward and outward remittance, Bank Indonesia is currently preparing regulations pertaining to money remittances in Indonesia. The regulation will stipulate terms and conditions as well as define the responsibilities of the money remittance provider. The regulation is expected to enhance transparency, security and customer protection. Furthermore, corresponding to advances in technology for electronic transactions, Bank Indonesia in cooperation with the Ministry of Communications and Information are currently preparing a draft of Information and Electronic Transaction laws. These laws will stipulate the use of electronic evidence including money remittances. With this regulation, it is expected that certainty in law enforcement for electronic transaction will be assured and, therefore, help restore public confidence in using electronic means of payment.

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Box 5.1

10% Minimum Payment for Credit Cards

Bank Indonesia initially regulated the provision of Payment Means Using Cards via Bank Indonesia Regulation number 6/30/PBI/2004 dated 28th December 2004 concerning the Service Provision of Payment Means Using Cards, featuring for major articles: 1) Payment System Regulation; 2) Customer Protection; 3) Supervision; and 4) Prudential Regulation. This regulation was revoked and subsequently replaced by Bank Indonesia Regulation number 7/52/PBI/2005 dated 28th December 2005, for which the technical guidelines are elucidated in three circular letters. This regulation itemizes prudential regulations in more detail, including the minimum monthly payment of 10% for credit cards. Effective commencing 28th December 2005 all credit card issuers must comply with the new regulation. Some issuers, notwithstanding, have gradually demanded a 10% December 2004. Applying for credit cards is generally less stringent and hassle free and, therefore, customers can easily obtain more than one credit card. Nevertheless, credit card holders seem to be unaware of the high interest rates charged, effectively 28% - 42.0% p.a. for retail transactions and 33% - 72% for a cash advance. This minimum payment since 28th

has affected the repayment capacity of holders heavily indebted by credit card financing. Credit card debts materialize when the holder does not fully repay retail transactions or when she/he repays only the minimum payment. As the vast majority of credit card issuers only demanded 5%, the holders were finally overburdened with the compounded interest rates. In previous cases, customers ended up with overlyindebted principal and interest arrears which, in turn, lead to upward credit risk pressures on banks. Considering these rationales, Bank Indonesia promulgated a regulation demanding a 10% minimum payment of the outstanding monthly balance. The ultimate objective of this regulation is to protect both the customer and the bank. From the customer»s perspective, with a 10% minimum payment it is expected that the customers manage their finance better and limit their probability of default. Customers will be able to make fewer, higher value installments of their monthly outstanding balance and, therefore, reduce their debt. From the bank»s perspective, this regulation helps banks mitigate credit risk emanating from unsecured lending. Additionally, banks are expected to exercise more prudent selection of the applicants.

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Hedge Fund Activities in Developing Countries and Efforts to Maintain Financial Stability
Dwityapoetra S. Besar

This paper discusses the development of investment in hedge funds, especially in emerging market countries and their impact on financial stability. In general, investment in hedge funds has positive impacts on a country primarily in creating an efficient equity market. Nevertheless, in practice several criteria must be met in order to have an efficient market, namely: (i) to monitor potential hedge fund crises; (ii) to monitor the relationship with banks and financial markets; (iii) to enforce good corporate governance; and (iv) to protect the consumer. Therefore, in a global context, global consensuses and agreements are required to build global and regional cooperation. Such cooperation will assist in the monitoring of global hedge fund activity as well as create and maintain global financial stability.

BACKGROUND
A high degree of volatility marked the conditions of financial markets in developing countries. Financial instability was triggered by a period of high capital inflows followed by subsequent outflows and a higher cost of borrowing. The external balance sheet sparked a monetary crisis in Asia in 1997 and distortions in the Brazilian economy in 2002. The crises were not only very costly for emerging countries but also influenced industrial countries financially linked to the crisis-hit countries and the global equity market. Understanding the main trigger of volatility is an important element of judging global and domestic financial system risk. During the Asian crisis, hedge fund activity was considered one of the agents which raised volatility and pressure in the financial system in Southeast Asia. The most famous being the Soros Quantum Fund. The Prime Minister of Malaysia called its action amoral, unnecessary and unproductive. On the other hand, there are suggestions that hedge funds are critical to maintain liquidity supply in the forex market. Therefore, hedge fund activities as free as international equity flows plus fundamental weaknesses in developing countries indicate that developing countries must prepare to protect themselves from potential global crises.

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Graph A4.1 Stock Market Indices and Hedge Funds at Emerging Countries
400 350 300 250 200 150 100 50 0 Jan 1997 Apr 1998 Jul 1999 Oct 2000 Jan 2002 Apr 2003 Jul 2004 Oct 2005 Stock Market Indices Hedge Fund Index 15.00 10.00 5.00 0.00
Asset USD billion

Graph A1.2 Global Hedge Funds
1400 1200 1000 800
(5.00) (10.00) (15.00) (20.00) (25.00)
Asset Total

10000 8000

6000 4000

600 400 200 0 1995 1997 1999 2001 2003 2005
Source: Hennessee Group LLC;IFSL 2005, Van Hedge 2006

2000 0

Source: Bloomberg

THE NUMBER OF HEDGE FUNDS AND FUNDS UNDER MANAGEMENT
Hedge Funds were initially developed by Alfred Winslow Jones in 1947 as a group of funds for short and long position investment, using arbitrage, undervalued securities, bonds trade or options which are invested in every combination to achieve yields with low risk. The improvements gained in assets managed by hedge funds has sharply risen in the last ten years, from US$257 billion to more than US$ 1 trillion covering more than 8,000 hedge funds. The scale and complexity of hedge fund activities are a concern for regulators because their free flows can distort financial sectors. Currently, hedge fund activities are classified into three groups, namely relative value, event driven and opportunistic. Relative value is an investment with convertible arbitrage, fixed income arbitrage and equity market neutral strategy. Event driven is an investment with risk arbitrage, distressed and CTA managed futures. These two groups of hedge funds represent investments which use models to detect a chance for arbitrage. The activities in these groups are usually followed by hedging transactions leaving the investment with low risk. Meanwhile, opportunistic or macro funds generally operate in global macro, short seller, long specialist, emerging markets and long/short equity areas. This group

tends to make speculative transactions based on macroeconomic and financial market analyses. Assets managed by the hedge fund industry totaled about US$1.130 billion by the end of 2005. This is a 13% increase on the previous year and almost double the amount of assets three years ago. Generally, hedge funds use leverage at a level 5 to 9 times that of equity. The number of hedge funds increased by 6% in 2005; reaching 8,500 companies. Research conducted by Tower Group estimated that hedge fund assets will grow by 15% p.a. from 2006 to 2008. Based on Alpha Magazine, hedge funds placed in the top five position, based on assets, are Goldman Sachs Group, Bridgewater Associates, D.E. Shaw Group, Farallon and ESL Investments.

Funds under Management
Based on hedge fund research regarding strategy over the last 15 years, there has been a significant change in the composition strategy of fund management. In the 1990s, macro funds were considered as the most active hedge funds with a share of 70% from total fund management, followed by Relative Value Arbitrage with a share of 10%. This differs widely from conditions in 2005, where Equity Hedge Funds were dominant with a 30% share, followed by Event Driven Funds with 14%. In addition, Macro Funds only commanded an 11% share.

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This indicates that hedge fund activities have not only become relatively stable but also over a longer horizon. Nevertheless, macro fund strategy still requires attention globally and from developing countries too.

require regulation and supervision in order to create an efficient, liquid and sound financial market towards the ultimate goal of financial stability.
Table A1.1 Hedge Fund Strategy

Hedge Fund Investment in Developing Countries
The hedge funds industry is predicted to decline in the future. An indicator of this is stock market stability over recent years, which undermines hedge funds speculation. Besides, high competition and tight regulation by the supervisory authorities in US and UK have pushed hedge fund activities towards developing countries. The relative value strategy adopted gives the prospect of lower returns. Some hedge funds in recent times have reported a low rate of return, oftentimes close to the initial equity. Meanwhile, 25 hedge funds in Asia have successfully raised their assets to a value of US$22.6 billion. This highlights the switch in the hedge funds industry to developing countries, especially in Asia. Although the size of the Asian market is relatively small compared to USA and Europe, opportunities remain wide
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Strategy

% of Total Managed Funds 1990 2005 30.0 13.8 11.8 10.7 7.9 4.8 4.7 4.5 4.0 3.3 2.2 1.4 0.4 0.3 0.2 35.7 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15)

Equity hedge Event driven Relative value arbitrage Macro Fixed income Sector Distressed securities Equity non-hedge Emerging markets Convertible arbitrage Equity market neutral Merger arbitrage Market timing Short selling Regulation D Fund of Funds

5.3 3.8 10.1 71.1 3.2 0.2 2.4 0.6 0.4 0.5 1.7 0.6 0.1 4.9

(3) (4) (2) (1) (5) (12) (6) (8) (11) (10) (7) (9) (13)

Graph A1.3 Global Hedge Fund Investment - Per Region
%

2 9

open, such as in the stock and commodity markets. Japan and Australia lead the Asian hedge funds market, including Sparx Asset Management located in Tokyo, which manages funds totaling US$5.2 billion. Over the next three years, global hedge funds will return to Europe (26%) and Asia (10%). Hedge funds markets will grow more rapidly in developing countries due to weaker regulations and poorer legal framework. Hedge funds located in Australia will remain the prime investor in Asia Pacific. In 2005, 25% of total assets, totaling US$115 billion, were managed in Australia. Other countries which invest in hedge funds in Asia are Japan (20%), Hong Kong (14%), USA (23%) and UK (16%). Developing countries, especially in Asia have to prepare themselves to avoid risks and minimize the chance of hedge fund crises. Hedge funds activities
80

3

2 10 26

60

40

86 62

20

0 2002 Others Source: IFSL, Hedge Funds, March 2006 Asia 2005 Europe US

THE IMPACT OF HEDGE FUNDS ON FINANCIAL STABILITY
Hedge funds in the 1990s grew rapidly earning high yields. This was the result of good hedging performance, access to modern techniques and markets as well as high flexibility in hedge funds activities. This condition is to be considered as ideal and made hedge funds a firm

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institution. Nevertheless, such characteristics and the strategies adopted for hedge funds transactions created instability. One such strategy that triggered high volatility was global macro. Global macro uses a top down global approach investing in many instruments to generate profit from inaccuracies in market price movements stemming from global economic shifts, geopolitical conditions, global imbalances and other significant changes. In addition, the high level of leverage behind hedge funds activities exacerbated the risks associated with hedge funds activities. High leverage is raised to boost the position and potential return assuming that the potential return is higher than the level of leverage. Hence, the hedge funds industry looks for the highest return neglecting to pay attention to the soundness of economy fundamentals and financial stability. Nevertheless, this condition will not persist because, in the long run, returns decline due to capacity constraints, dynamic market movements, systemic risk and better regulation. This situation motivates developing countries to minimize the negative impacts.

predict and prepare for risk and potential crises that result from hedge funds activities. Monitoring disturbances and hedge funds exposure is crucial to limit the possibility of financial crisis risk and alleviate the impact of a crisis. As an initial idea and reference, this can be performed by analyzing the relationship between the change in the hedge funds index in developing countries and the change of foreign exchange and JCI.

Correlation of Hedge Funds Index Growth in Developing Countries, JCI Performance and Rupiah Foreign Exchange
Currently the global stock exchange has collected investment funds totaling more than US$1 trillion. Hedge funds tend to seek portfolios that have a lower correlation with stock index (which is well diversified) but this entails high risk, especially in variance between hedge funds and the type of portfolio and its investor. Hence, hedge fund investors have to chance high risks by choosing portfolios suffering of loss (Malkiel and Saha, 2005). The correlation between hedge funds indices in

Foreign Exchange and the Jakarta Composite Index (JCI) as Financial Instability Indicators
Assessments are performed to observe distortions in financial stability by monitoring the foreign exchange and stock markets. One of the main indicators in countries that are suffering a crisis is when the level of foreign exchange surpasses its fundamental value (Goldstein, Kaminsky and Reinhart, 2000).This condition encourages hedge funds in the foreign exchange market which puts pressure on a country»s currency. Meanwhile, the stock market can describe the intensity of hedge funds investments, which require a high level of return and portfolio diversification. Hence, positive movements in JCI should be in line with hedge funds indices of other developing countries that invest in the Indonesian stock market. A country should be able to

developing countries with foreign exchange and JCI shows a similar relationship pattern, except for foreign exchange and JCI during a crisis period. This difference is primarily attributable to extensive stock selling and dollar buying by investors. Movements in the hedge funds indices of developing countries is in line with the JCI and rupiah exchange rate to the US$. This is because the JCI forms part of the hedge funds indices of developing countries and, therefore, a change in investment pattern does not negatively impact foreign exchange. In other words, there is a significant positive correlation between the hedge funds indices of developing countries, the JCI and rupiah foreign exchange, which indicates the domination of hedge funds in emerging markets. The high level of hedge funds transactions in Indonesian stock market is also reflected by material correlation, however, not in the foreign

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Table A1.2 Correlation of Hedge Fund Index, Exchange Rate and Jakarta Composite Index
%
Hedge Fund Index Sample (1997-2006) Global Hedge Fund Index EM Hedge Fund Index USD/Rp Crises Periode (1997-98) Global Hedge Fund Index EM Hedge Fund Index USD/Rp Post Crises (2000-06) Global Hedge Fund Index EM Hedge Fund Index USD/Rp
Sumber: Bloomberg, MSCI

movements. Generally, regulations in developing countries are relatively weak, leaving the country open to huge contagion risk. Different from mutual funds, hedge funds can include speculation in many instruments, from real estate to future energy. In order to ensure a

Exchange Rate Rp/USD

JCI

70.7

-9.4 -8.3

38.2 32.9 -4.0

high return, hedge funds management use a strategy that entails high risk, for example by using loans to add investment strength and regularly selling short (if the asset price will drop). A strategy which has high risk can earn a high return but can also incur losses. One such experience was found in Connecticut, by Long Term

71.7

-7.3 -2.3

61.6 41.5 20.4

73.0

-15.9 -12.6

28.0 30.9 -41.2

Capital Management (LTCM), which suffered high losses in 1998. Despite the guidance of a Noble Prize winner in economics and expertise from Wall Street, LTCM carried out massive speculation on bonds until the price

exchange market. This strategy of hedge funds transactions is defined by the level of yield and tends to be short term. Furthermore, it is highly susceptible to a sudden capital reversal which can spur financial instability. This condition should be anticipated. Preparations must be made to prevent financial instability, therefore, dissipating the pressures on financial markets in Indonesia and other emerging market countries.

plummeted. In order to avoid further chaotic financial conditions, a coalition of banks on Wall Street sponsored by The Federal Reserve bailed out LTCM. Such a disastrous drop is prices provided an invaluable lesson for other market agents. Nevertheless, the extensive number of hedge funds seeking high gains, not backed up with good quality, caused market instability. This is often followed by financial scandal and insider trading, which happened to KL Financial (US$200 million loss), Bayou

FACTORS THAT IMPROVE FINANCIAL STABILITY
In terms of the financial market, strong correlation is evident between investment through hedge funds and a country»s financial market, including in developing countries. In order to maintain financial stability, several important aspects require attention, namely (i) hedge funds crisis; (ii) its impact on banks and the financial market; (iii) good governance; and (iv) consumer protection.

Management LLC (US$300 million loss) and Man Group. A decline in hedge funds is also caused problems affecting its counterparty. One major event was when the settlement of futures transactions was postponed due to problems in Refco, which is under the supervision of the Securities Exchange Commission (SEC) and the Financial Services Authority (FSA). As a result, Refco is forbidden to settle transactions. Capital flows from large investors affect hedge fund

Hedge Funds Crisis
A decline in hedge funds is a serious concern, especially for developing countries with weak fundamentals and susceptible to global capital

performance and conditions. Based on Chicago»s Hedge Fund Research Report in December 2005, up to September 2005, there were 484 hedge fund defaults (6%). Although there are no hedge fund defaults in the most recent report,

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more are predicted. This period has therefore become known as a hedge fund recession. The fall in hedge funds and its impact on other market agents requires more attention in terms of financial system stability in developing countries. This is because global hedge fund exposure is much greater than for forex reserves and the financial markets. A significant drop in hedge funds can spark market panic. If hedge funds are sold in a declining market, the market can spiral into crisis. This is even more important in markets which suffer from herding behavior, which generally occurs in developing countries. Besides, stocks crises influence other parts of the financial markets, especially the foreign exchange market.

such as BNP-Paribas, Royal Bank of Scotland, or Spanish owned banks. Such stock purchases are mainly based on the interest of foreign investors in bank acquisition, which improves the gains on hedge funds from the stock price spread. Buying bank stocks through hedge funds is a challenge for bank supervisors and regulators. From the supervisory side, it is difficult to supervise an indistinct hedge fund or a hedge fund unwilling to increase equity. In addition, if the hedge fund owns more than 51%, its financial report can not be supervised through consolidation. Emerging market countries should decide upon specific requirements for hedge funds seeking to buy bank stocks.

The Influence on Banks and Financial Markets
Hedge fund activity strongly influences other activities in the financial markets. The requirement for increasing returns for hedge funds supports a rise in debt, which is borne by banks and other creditors. Some large size banks, such as JP Morgan Chase, Deutsch Bank, UBS and Credit Suisse are the primary lenders for hedge funds to the tune of US$500 billion. This is a problem if hedge funds are invested speculatively, leaving the creditor»s bank with the risks. A hedge fund crisis affected Refco, a futures trader, which was almost bankrupted due to high bank debt. Supervisory and regulator assistance was required to protect the financial system from systemic risk. Furthermore, hedge funds are also influenced by ownership. In order to gain high returns, an exact strategy is applied to hedge funds, including buying long-term stocks. For example, Hedge Fund Toscafund and Lansdowne Partners purchased stocks of one of the largest banks in Germany, Commerzbank. In the transaction, they did not acknowledge themselves as the investor-owner. This phenomenon will expand through buying bank stocks,

Governance must be Improved
Unregulated hedge fund activities give rise to illegal activities. Even in countries such as the United States of America and United Kingdom, which are well regulated and practice good governance for hedge funds, illegal activities occur. Such instances evidence that hedge fund regulations and supervision are crucial. Generally, cases involve insider trading and market manipulation, such as Hedge Fund Pequot Capital Management which involved Executor Morgan Stanley. As a result, the supervisory authority agent, such as Financial Service Authority (FSA) in United Kingdom, refines regulations to avoid hedge funds from speculative or deceitful transactions. This action is important to reduce insider trading and market manipulation. The case of the Canadian Imperial Bank of Commerce (CIBC), which extended loans to hedge funds using late trading and market timing, shows how law enforcement a good governance are important. Another case is highlighted by Hedge Fund Wood River Partners LP and Wood River Partners Offshore Ltd managed by John

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Whittier, which caused millions of dollars of financial loss for the investor. In this case it was attributable to a poor audit process and bad investment fund management. Good governance, sound implementation and firm supervision are required to ensure healthy hedge fund activities in developing countries. These three points are important to create an efficient market, protect investors and stabilize the financial system, not only in developing countries but in the global markets.

Another deception case involves Samuel Israel III from Bayou Hedge Fund, which triggered losses of USD1.5 million. In this case, SEC as the supervisor and regulator has initiated court action against the perpetrators. Besides, limited comprehension in terms of projection calculations can affect small/retail investors. In such cases, profit projections are calculated by the Sharpe ratio formula and method. This method differs from the usual method because the calculations are based

Customer Protection
In recent years, capital flows from large investors (institutions) have declined by 44% compared to the first quarter of 2005. Therefore, hedge fund managers have begun to market their products through banks and pension funds. The minimum amount for investment has consequently dropped to just US$25,000. This condition must be supervised because it can trigger systemic risk and losses for the customer, especially retail customers. Based on research by the Fund Research Institute, in 1990 there were 600 hedge funds with total managed assets of US$38 billion. In 2006, it increased to 8,500 hedge funds with more than US$1 trillion. However, the amount invested has halved from US$24.6 billion to US$11.6 billion. In the United States of America during 2005, based on research by Securities and Exchange Commission (SEC), there were 51 cases of investor loss totaling more than US$1 billion. In developing countries, this represents a challenge because hedge fund activities are neither well regulated nor supervised. In addition, regulators have to expand their comprehension of hedge fund transactions. Ponzi Scheme is an example of deception. Bret Grebow from HMC International LLC caused the investor to suffer a US$5.8-million loss. Manipulation of documents and investment reports by Kirk Wright caused 500 investors to loose a total of US$185 million.

on average values and normal distributions in rate of return model, which creates more favorable results than can be expected in real terms. Generally, investment in hedge funds follows the principle that the higher the risk the higher the return. Therefore, investors tend to be more speculative. However, they have to realize the risks and the impacts of their investment. Furthermore, regulators have to protect small investors.

CONCLUSION
Hedge fund performance in the 1990»s was considered well developed with high potential returns supported by hedging, accessibility to modern markets and less regulation. Hedge funds were considered a firm institution. However, these characteristics and certain strategies taken caused instability in the respective market/ country. One strategy that triggers high volatility is global macro. Hedge fund managers use the strategy by applying a top-down global approach and investing in various instruments in order to profit from market price inaccuracies. There is a strong correlation between hedge fund investment in the money market and capital market, including developing countries. Therefore, in order to maintain financial stability, we must pay attention to several important aspects, such as

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(i) avoiding hedge fund crises; (ii) minimizing negative impacts on banks and financial markets; (iii) expanding the implementation of good governance; and (iv) protecting the customers, especially retail investor. In addition, global commitment is required to form global and regional cooperation in order to supervise global

hedge fund activities. A balance must be struck between legal protection and high performance so that hedge funds can develop and support a liquid market and maintain global stability. Emerging market countries must regulate hedge fund activities in order to create sound financial conditions.

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Reference

1.

Amin, G. dan H. Kat (2003),ΔStocks, Bonds and Hedge Funds: Not A Free Lunch!,Δ Journal of Portfolio Management, Vol. 29, No. 4, (Summer): 113-120.

6.

Fung, William, dan David Hsieh, (1999),ΔA Premier on Hedge Funds,ΔJournal of Empirical Finance, Vol. 6, No. 3 (September): 309-331.

2.

Berg, Andrew, dan Catherine Pattillo , (1999),ΔAre Currency Crises Predictable: A Test,Δ IMF Staff Papers 46(2): 107-138.

7.

Goldstein, Morris, Graciela Kaminsky, dan Carmen Reinhart, (2000),ΔAssessing Financial Vulnerability: An Early Warning System for Emerging Markets,Δ

3.

Caprio,

Gerard,

dan

Patrick

Honohan, 8.

Washington DC: Institute for International Economics. Malkiel, Burton G. dan Saha, Atanu (2005), ≈Hedge Funds: Risk and Return,Δ Financial Analyst Journal, Volume 61, No. 6.

(2000),ΔFinance and Growth: Policy Choices in a Volatile World. Washington DC: World Bank. 4. Drury, Giles (2006), ≈ Hedge Funds: A Catalyst

Reshaping Global InvestmentΔ, KPMG.
5. Eichengreen, B. dan Mathieson, D (1999), ≈Hedge

Funds: What Do We Really Know?,Δ International
Monetary Fund, September 1999.

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Article II

The Efficiency of Indonesian Foreign Exchange Market

Bagus Santoso1, Pungky P. Wibowo2

This paper outlines the test of forward market efficiency in Indonesia employing spot and forward rates of Rupiah against US$-5 days for a week delivery covering period of 4th September 1996 up to 7th October 2005. The result estimation indicates a possibility of biased forward exchange rate in the short-term. Nevertheless, in the long-term, forward rate is unbiased predictor for spot exchange rate.

I. INTRODUCTION
The concept of efficiency has a vital meaning in the financial market. It is used to explain the market condition in which the relevant information is perfectly reflected in financial asset prices. Market efficiency is very much related to the market responses which involves the new information (public and private information). Melvin (1995) argued that market is considered as efficient should the price is able to reflect all available information. In the case of foreign exchange market,

forward rate and the forward rate reflects the spot rate in
the future, then the market could be considered as efficient. On the other hand, if all available information could predict

future spot rate in a better way than in predicting forward rate, then, the market could be considered as not efficient
yet. Market is efficient should no agent is able to gain some extra profit from the transaction based on the available information (Jensen, 1978; Levich, 1985; Ross, 1987). Should a market, particularly financial market, is considered as efficient, then the market agents are not able to predict the foreign exchange rate and also not able to set a trading model that may give extra profits for themselves. In this case, the basic problem is about the market dynamic factors and the redefinition of market

market efficiency would be established if the exchange
rate of spot and forward could adjust the new information in the very short-term. According to market efficiency, the

forward rate would be different with the expected future spot rate; this difference is called risk premium. However,
should the available information do not change the
1 Lecturer at Gajah Mada University; bagussantoso@ugm.ac.id 2 Senior Bank Researcher at Financial System Stability Bureau √ Directorate for Banking Research and Regulation, Bank Indonesia; pungky_pw@bi.go.id

efficiency.
The characteristics of market efficiency based on the conventional economists is a situation which there unable

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the possibilities of market agents to gain excess return through their trading transactions. Such condition is caused by the assumption that all investors (market agents) refer to the rational expectation model. The efficient market transpires if each market agent can find partner which is suitable in every transaction; including the time and the price which are not biased by the hidden information. Therefore, market could be considered as efficient should follow two requirements: First, all information are available for each market agent and the decision maker. Second, the possibility in the differences in dimension or time scale and the heterogeneous expectation from the market agents. This paper analysis aims to test the unbiasedness and efficiency of forward market exchange rate in Indonesia. Therefore, banking and financial control in order to maintain the stability of financial system will be developed. The structure of the paper could be organized as follows: Chapter 1, it would discuss the background of market

A Martingale Discrete could be understood as

sequence of the value from the conditional events. The
value sequence could increase or decrease in the time sequence. Mathematically, the Martingale Process could be written as follows: For the sequence:

(X(t) : T = 1,2,...........), if, E{X(t + 1) X(1), X(2),...., X(t)} = X(t),

Then sequence {X(t)} is considered as Martingale. The Martingale Process involves sub-Martingales and

super-Martingales. A random process (X(t), Gt : t ∈ Τ) is
considered as sub-Martingale process if: {|X (t)|} < ∞ and E {X(t) | Gs} > X s a.c., s < t; s, t ¤ T Meanwhile the process is considered as super-

Martingale process if,
E {X(t) | Gs} ≤ X s a.c., s < t; s, t ¤ T Therefore, a Martingale process involves sub-

Martingale process and super-Martingale process.
If Gt is the historic information in which the Martingale process is conditioned, we could define a Martingale-

efficiency. Chapter II, it would present the literature review.
Chapter III will conduct the discussion about research method. In this Chapter III, it explains about the data and research model which employed in order to test the unbiasedness and efficiency of forward market. Chapter IV presents the estimation and analysis results. The conclusion will be presented in Chapter V.

Difference. A random process {X (t), Gt: t ¤ T} is considered
as Martingale-Difference (MD) if, X (t) = Y (t) – Y (t-1), X(1) = Y(1) In the random process {X (t), G t : t ¤ T} is Martingale. Besides that, the MD process could be defined as E { X (t) | Gt-1 } = 0 if, E { X (t) | Gt-1 } = E { Y (t) – Y (t-1) | Gt-1 }

II. EFFICIENT MARKET HYPOTHESIS (SAMUELSON-FAMA EFFICIENT)
Based on the EMH approach, we have to concern about the concept of Martingale Process. The concept of Martingale Process is useful in the time series observation which is mutually dependent. As an example, when our observations are acquired from the feedback process; when the dynamic process is nonlinear ; and when the information set increases since there is observation accumulation.

= E { Y (t) | Gt-1 } - E { Y (t-1) | Gt-1 } = Y (t-1) - Y (t-1) = 0 The MD process was employed by Samuelson (1965) and (1970) in order to define the efficient market pricing which assumed the independence and the stationary. However, the critics from Mandelbrot (1966) stated that MD process posses a limitation in explaining the efficient of empirical speculative market. Following Fama»s definition of market efficiency, foreign exchange market will be efficient if exchange rates

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reflect all information available perfectly. Market efficiency theory utilizes expectation since it deals with information. Moreover, using rational expectation principles which states there are no systematical errors in forecasting implies price change is not predictable. However, efficiency does not require prices or rate of returns follow a random walk with zero mean or constant drift.

adanya signifikansi pasar yang tidak efisien. Houthakker analysed future price from the clothes, corn, and wheat. He found that the profit could be gained by taking the

long position; or in the other word, the profits could be
gained from the investment on the assets which posse the positive systemic risk; and consequently the today price from the future price could be predicted by expectation value of future spot price on the maturity date.

The Development of Market Efficiency Definition
The idea about the heterogen expectation from the market agents become the main issue in the theory of

Moreover, Keynes (1930) and Hicks (1939) have discussed a situation which is called as normal

backwardation. It is defined the backwardation occurs
when the speculator has tenedency to take long position, while hedger has tendency to take short position. This situation could occurr since the speculator needs compensation from the market risk that they may have. On the other side, hedgers would loose their average profits. Hedger would receive this situation since the future

market efficiency which is observed by the economists.
Shiller (1989) stated that most of the bond market agents do not follow the rational expectation model. They tend to follow the trend and format that has occurred. Frankel and Foot (1990) also stated that foreign exchange market involves the speculative aspects and the impacts of tecnical analysis on the strategy of foreign exchange trader. Therefore, the possibility of time expectation, which is different, become the main focusamong the researchers in expalining the theory of market efficiency. The other

contract could decrease rge posibility risks that may occur.

Types of Market Efficiency
There are three types of market efficiency (Asal, 2000): 1. Weak form efficiency, where prices reflect all information contained in the past prices. Therefore, it is impossible to earn superior returns by looking

efficiency concept is speculative efficiency. This concept
considers no possibility of unexploited speculative profit.

Degree of Market Efficiency
The identification of the degree of market efficiency is not only useful in the accuracy of identification, measurement, analysis and the risk management of financial market, but also used to determine the accuracy in financial instrument valuation and pricing; either both

for patterns in prices. Testing the weak form efficiency could be done by using filter test and serial correlation test. According to the Granger representation theorem, returns for at least one currency in the co-integrated system is predictable based on the error correction term under the co-integrating systems of spot exchange rates. This predictability implies a violation of the weak-form market efficiency hypothesis. It also means that non-stationarity of the currency risk premium would imply inefficiency of the foreign exchange market efficiency (Barkoulas et. al, 2003).

fundamental or derivative.
The basic assumptionto measure the market

efficiency is whether the forecaster could predict accurately
either the return or the risk taht may occur in a market (Cowless, 1933). Houthakker (1957) found that there was a market significancy which is not efficient menemukan

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Weak-form efficiency can be tested by using the random walk model yt = yt-1 + εt (1) 2.

that the forward premiums for six major currencies are stationary and therefore support the efficient market hypothesis. Semi-strong form efficiency, where by including all the public information available. The form of this test is based on the degree of sensitivity or market response to news or information announcement. Investor does not get superior profit by using all public information available. Geweke and Feige divide semi-strong form efficiency into: a. Single market efficiency: all public information for a single exchange rate is in the information set b. Multi market efficiency: the information set contains all information including information for other exchange rates. The semi-strong efficiency test could be conducted by event study and by analyzing the abnormal return. In the event study, it is analyzed how the market responds to certain event which is announced to the public. While, in the abnormal return analysis, market is considered to be not efficient should there is one or several market agents who experience abnormal return in the long period based on the past information and public information. 3. Strong form efficiency, where by including all the private information, it is not possible for a market participant to make abnormal profits. In the strong form market efficiency, the price has to reflect all available information. This kind of test analyses whether specific investors or certain groups have private information in order to get profit or not. A group of information contains all information that includes private information and market insider

Martingale and random walk theory of market efficiency imply that since information affects exchange rates randomly, therefore spot rates are unpredictable. In addition, since new information is independent to all previous information, the price changes cannot be predicted by the past price changes. In previous studies, random walk model is used to analyzed observed price behavior in speculative market, the martingale model posits that market equilibrium only can be described in term of expected yields or price changes, and the random walk model entails that yields or price changes are identically independently distributed. Theoretically, random walk model requires stricter condition than Martingale condition. Early research concentrated on the autocorrelation due to technical difficulties, so it is more concerned on martingale properties than random walk. Feature that distinguishes exchange rates markets to any other markets are they are also determined by speculators and central banks behavior. It is difficult to determine whether inefficiency is because of the destabilizing or central bank»s interventions. Studies on exchange market efficiency by Poole (1967) was carried out by using autocorrelation test and filter rules found serial dependence. Dooley and Schafer (1975) rejected the random walk hypothesis in their study. (Barkoulas et. al, 2003) test the unit-root hypothesis they use a panel multivariate unit-root test, the Johansen likelihood ratio (JLR) test for 1, 3, 6 and 12 month contract maturities under the condition of risk aversion. The study uses six major currencies started from 01/02/1980 to 12/31/1998. The results shows

trading which is not profitable.
All the profesionals manage their portfolio s by employing resources in order to get and use the

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personal or private information. The strong form market efficieny is conducted by testing portfolio performance in reflecting personnal or private information. In the strong form market efficiency, the test is conducted based on the available private information which may be possesed by market agents. The market agents who may possess such information are insider

expected spot exchange rate (s) at time t+k (all variables are in logarithms). Equation (3) states that expected exchange rate is the best predictor of the actual exchange rate: St+k = α + β [Et, (St+k)]+ εt+k (3)

where et is a random error which is uncorrelated to the information set at time t and substituting (2) into (3) yields: St+k = α + β ft,t+k + εt+k (4)

trading, securities analysts and finance managers.
Efficient market hypothesis have strict assumption i.e. frictionless world, no transaction costs, and traders have homogeneous expectation. Some researches have proved that efficient market hypothesis is not compatible when the assumptions are relaxed, therefore they also have attempted to impose less stricter assumptions. Common claim perceived that nominal exchange rate follows random walk behavior, therefore it can be tested by unit root test, AR, and ARIMA. The concept of co-integration is also used to test whether there are long run association among spot rates and/or forward exchange rates. For instance, the existence of co-integration opposes the market efficiency hypothesis, since a co-integrated system of spot rates implies predictability of returns in at least one currency (Barkoulas, et.al. 2003). Another early test of market efficiency is autocorrelation test, either using portmanteau statistics or modified portmanteau statistics. In foreign exchange market, the efficient market hypothesis necessitate that the forward rates is the best predictor of future spot rates. Following Bernhard and Leblang (1999) this proposal are formulated below: ft,t+k = Et (St+k) (2)

To avoid non-stationary variables, both the spot and the forward exchange rates are written as first differences: St+k – St = α + β [ ft,t+k – St ] + εt+k (5)

If a time-varying risk premium has the same stochastic properties with the error-correction term from the co-integrated system under risk aversion conditions, then the foreign exchange market is efficient, in other words it must be covariance stationary. The risk premium can not be observed, however they depend on the order of integration of the forward premium. Thus, stationarity of forward premium would directly imply stationarity of the currency risk premium. Furthermore, it is in line with the temporal behavior of the error correction term in a co-integrated system of spot exchange rates (Barkoulas, et.al. 2003).

Unbiased Forward Rate Hypothesis
The alternative method to measure exchange rate expectation is conducted by employing forward exchange

rate since forward exchange rate is viewed as unbiased
predictor for forward spot rate. Based on the rationality assumption, forward rate would be the same to the expectation of future spot rate. s t+1 = ft
e

(6)

The equation means that the forward exchange rate (f) at time t for delivery at time t+k should equal the

Equation (5) could also be written as follows: E[ St+1 – ft It ] = 0 (7)

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Equation (7) states that forecast error employs

was not efficient. In this regard, the analysis was done within yearly interval. The analysis based on the yearly data also concludes the same result which employed the whole

forward rates based on the average equal to zero.

Composite Efficiency Hypothesis
This hypothesis incorporates the previous two hypothesizes which are Random Walk Hypothesis and

data.

III. METHODOLOGY The Research Model
In an unbiased forward exchange market, the forward transaction in t for t+1 delivery is equal to the spot rate at t+1. In terms of weekly data, the forward rate of today transaction should equal to spot rate of the following week. St+1 = β0 + β1Ft + β2Zt + μt (10)

Unbiased Forward Rate Hypothesis. The expectation of future spot rate is the weighted average of spot rate.
s t+1 = ϖst + (1 – ϖ) / ft
e

(8)

This equation involves two kind of information which are past information ( st ) and future information or rational

expectation ( ft ).

Forward Premium Puzzle
In efficient forward market, forward rate should be a good predictor for the future spot rate. In line with this, there is a concept called Forward Premium Puzzle. Forward Premium Puzzle is explained as follows. Δst = α + β ( ft-1 – st-1 ) (9)

The analysis is focused on weak-form market efficiency test. Therefore, the Z variables on the Equation (8) are the the past values of spot rate and forward rate. Data in financial sector are mainly not stationary. Due to stationary reason, the above equation is modified to be Equation (12). ΔSt = α + β1 (Ft 1 - St 1) + β2Zt H0: α = 0, β1 = 1 (11)

Based on efficient market hypothesis (EMH), Equation (10) requires α = 0 and β =1 (nil hypothesis). This hypothesis has repeatedly tested for different currency and period. The results mainly suggest no rejection of nil hypothesis, even β is negative for some cases. This condition indicates forward premium puzzle.

The Steps in Analyses
In order to test the unbiasedness and efficiency in forward market, it would conduct the graphics and econometric analysis. In the graphics analysis, it would

Previous Studies
The study which considered the state financial condition was developed by Asal (2000). This research is conducted by Asal by analyzing stock market efficiency in Egypt and testing weak-form efficiency. The data which was employed to test weak-form efficiency are daily returns data since 1 January 1992 up to 15 March 1997. The employed data are data in index form in order to capture the impact of changes in regulation switching on the market as a whole. The analysis result which employed three methods above indicates that Egypt stock market
st th

evaluate the development of spot exchange rate and forward exchange rate. Besides that, it would also analyze the forward premium and exchange rate volatility. In the econometric analysis, it would conduct several tests, either for unit root test and co-integration test. ARCH, GARCH and ADL model are also employed to test the unbiasedness in forward market. The sample period is also divided in order to evaluate whether there us a structural break before and after the 1997 financial crisis.

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IV. ANALYSES RESULTS Graphical Analysis
,6 ,4

Graph A2.3 Changes in Spot Rate Vs Forward Premium

Graph A2.1 Spot and Forward Rate (One Week delivery)
18000 16000 14000 12000 10000 8000 6000 4000 2000 97 98 99 00 01 02 03 04 05 ST FT_1

,2

,0 -,2 Log (FT_1/ST_1) -,4 1997 1998 1999 2000 2001 2002 2003 2004 2005 Log (ST_1/ST_1)

Econometrics Analysis
Furthermore, the test of unbiasedness and the efficiency of forward market are continued with econometric analysis. The results could be presented as follows:
Graph A2.2 Forward Premium

,06 ,04 ,02 ,00 -,02 -,04 Log (FT_1/ST_1) -,06 1997 1998 1999 2000 2001 2002 2003 2004 2005

1. Unit Root Test
Table A2.1 Unit-Root Test
Variable Sample ADF PP KPSS Conclusion

LSt

All

-2.5749

-2.5179

2.3958 Non Stationary

LFt

All

-2.5034

-2.5015

2.3639 Non Stationary

Based on graph A2.1, the forward rate for one week
D(LSt) All -17.3639 -48.2007 All -20.8401 -48.6332 All All -7.6321 -13.3654 -9.0448 -38.0330

0.3136 Stationary 0.3072 Stationary 0.2716 Stationary 0.1828 Stationary

delivery is seen coincided. In Figure 1, forward premium, which is the rate of change of forward rate to spot rate, is fluctuated around zero. This means that the ratio of forward rate to spot rate is nearly one. Graph A2.2 describes the forward premium or rate of change of forward rate to spot rates. The time horizon in this research indicates that forward rate ratio against spot rate is almost equal to 1 (in the logarithm, it is almost close to zero), even though the volatility looks very high. However, this forward premium volatility is relatively smaller than exchange rate volatility as indicated by graph A2.3. The exchange rate volatility occurred mainly since 1997 financial crisis.

D(LFt) LSt-LSt_1 LFt_1-LSt_1

The unit root test of spot exchange rate and forward exchange rate are conducted in logarithm form. Table A2.1 describes that the result of unit root test on exchange rate is not stationer, either conducted by Augmented DickeyFuller (ADF) test, Phillip-Perron test and Kwiatkowski, Phillips, Schmidt, and Shin (KPSS) Test. Both series has order 1, I(1), since they become stationer after they are converted into first difference. Table A2.1 also indicates that series LSt-LSt_1 (rate of change spot rate in period t deducted

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by rate of change spot rate in period t-1) and LFt_1-LSt_1 (rate of change forward rate deducted by rate of change spot rate in period t-1) are stationer.

normalized co-integrating coefficients which posses 1 as its value. It implies that in the long-term, any 1% change in forward exchange rate would be followed by the changes in spot exchange rate by 1%. Therefore, in the

2. Vector Autoregressive (VAR)
Furthermore, VAR method was employed in order to determine the optimum lag. The test is conducted by employing LR, Forecast Prediction Error (FPE), Akaike info criterion (AIC), Schwarz criterion (SC), and Hannan-Quinn criterion (HQ) methods. The test was started since the longlag which is lag 60. The estimation results in Table A2.2 indicates optimum lag which is different in every test method, except for the results of FPE and AIC which gave the same optimum lag that is lag 32.
Table A2.2 Optimal VAR Lag Length LSt and LFt_1
LR 51 FPE 32 AIC 32 SC 7 HQ 10

long-term, forward exchange rate is unbiased estimator from spot exchange rate.
Table A2.4 Johansen Cointegration Test LSt and LFt_1
Hypothesized No. of CE(s) None ** At most 1 ** Ω Eigenvalue 0.0100 0.0033 Trace Statistic 31.1174 7.7233 5 Percent Critical Value 15.4100 3.7600 1 Percent Critical Value 20.0400 6.6500

1 Cointegrating Equation(s): Log likelihood 14941.24 Normalized cointegrating coefficients (std.err. in parentheses) LST 1.0000 Std Error T-Stat LFT_1 -1.0011 0.0015 -0.7047

4. The Test of Unbiased Forward Exchange Rate in the Short-Term

3. Johansen Cointegration Test
Based on the results of optimum lag that are conducted by all five methods above, it is also conducted the co-integration test by employing the Johansen Cointegration and forward exchange rate. The test results could be followed in Table A2.3 and A2.4. The test results indicate that there is one-to-one relationship between spot and forward exchange rate. This finding is described by long-run coefficient and
Table A2.3 Johansen Cointegration Test between LSt and LFt_1
Lags interval: 1 to 31 Ω Ω Ω Ω Selected (5% level) Number of Cointegrating Relations by Model (columns) Data Trend: None None Linear Linear Quadratic Rank or No Intercept Intercept Intercept Intercept Intercept No. of CEs No Trend Trace Max-Eig 1 1 No Trend 1 1 No Trend 2 2 Trend 1 1 Trend 2 2

In the short-term, Indonesian forward market experiences forward premium puzzle. In this regard, the coefficient in premium forward in Table A2.5 is very far from 1 and is also not significant. Meanwhile, the hypothesis, which states that the coefficient is equal to zero, is rejected since the coefficient is significant. This result is not really
Table A2.5 Unbiased Forward Rate Test (1), All Sample
Dependent Variable: LST/LST_1 Method: Least SquaresΩ Sample(adjusted): 9/12/1996 10/03/2005 Variable C LFT_1(-1)/LST_1(-1) Coefficient 1.00497 -0.00458 Std. Error 0.17671 0.17669 t-Statistic 5.68715 -0.02594 Prob. 0.00000 0.97930 1.00038 0.00546 -7.58137 -7.57649 0.00067 0.97930

R-squared 0.00000 Adjusted R-squared -0.00042 S.E. of regression 0.00546 Sum squared resid 0.07042 Log likelihood 8959.39371 Durbin-Watson stat 0.35581

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion F-statistic Prob(F-statistic)

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different, should it only employ the observation sample since 2002 up to October 2005 (Table A2.6). Furthermore, should it is analyzed more deeply, the estimation results indicates autocorrelation problem. This result is confirmed by the score of Durbin-Watson test which indicates a quite high positive autocorrelation.
Table A2.6 Unbiased Forward Rate Test (2), Sample 2002 - 2005
Dependent Variable: LST/LST_1Ω Method: Least Squares Sample(adjusted): 1/01/2002 10/03/2005 Variable C LFT_1(-1)/LST_1(-1) R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat Coefficient 0.9432 0.0568 0.0009 -0.0001 0.0013 0.0016 5134.5989 0.4583 Ω Ω

accommodate the possibility of overlapping data. The estimation results could be followed in Table A2.7. In Table A2.7, it could be seen that the coefficient of both forward premium or the lag of forward premium is significant but far away from 1. This situation indicates the forward premium puzzle. Meanwhile, the lag of spot rate changes indicates the coefficient which is relatively bigger and significant. Therefore, in the short-term, the dominant that would affect the rate of change in the spot exchange rate is the past value from the rate of change in spot exchange rate itself. Furthermore, the components of ARCH and GARCH,

Std. Error 0.0590 0.0590

t-Statistic 15.9741 0.9628

Prob. 0.0000 0.3359 1.0000 0.0013 -10.4747 -10.4647 0.9269 0.3359

which are significant and have bigger values than 1, indicate the event of non stationary variance. In this case, it could be concluded that Indonesian foreign exchange market is very volatile. The situation above is not really different whether the sample observation is limited only in the 2001-2005 period as described in Table A2.8. It indicates that in the short-

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion F-statistic Prob(F-statistic)

5. Autoregressive Conditional Heteroscedascity (ARCH) and Generalized ARCH
Due to the autocorrelation problem, then the ARCH and GARCH tests are conducted. These tests are based on the assumption that in the financial time series, the residual values are often correlated to the residual values from the previous period. In this case, it also examined whether there are different behavior o results should the sample period is differentiated. The ARCH and GARCH components, which are incorporated into this model, could be used to accommodate volatility especially the conditional variance. In the ARCH, conditional variance of the dependent variable is modeled as a function from the past value of dependent and independent variables. While, in the GARCH, the past value of conditional variance is added to the ARCH model. In this estimation, it is also incorporated the component of moving average (MA) in order to

term, the rate of change in spot exchange rate is more dominated by the rate of change in spot exchange rate itself; while the impact of forward premium is relatively small.
Table A2.7 Unbiased Forward Rate Test (3), all sample
Coefficient C LOG(ST(-1)/ST_1(-1)) LOG(FT_1/ST_1) LOG(FT_1(-1)/ST_1(-1)) MA(1) 0.00010 0.73668 0.21379 -0.10737 0.20051 Variance C ARCH(1) GARCH(1) R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat Inverted MA Roots 0.00000 0.12360 0.90761 0.68006 0.67911 0.02762 1.79433 7201.08546 2.01512 -0.20000 Std. Error z-Statistic 0.00012 0.82737 0.01433 51.41477 0.02689 7.95136 0.03834 -2.80061 0.02529 7.92951 Equation 0.00000 2.13283 0.00419 29.47307 0.00182 499.40433 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion F-statistic Prob(F-statistic) 0.03294 0.00000 0.00000 0.00314 0.04876 -6.09584 -6.07629 714.21145 0.00000 Prob. 0.40803 0.00000 0.00000 0.00510 0.00000

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Table A2.8 Unbiased Forward Rate Test (4), Sample 2001 - 2005
Dependent Variable: LST-LST_1 Method: ML - ARCH (Marquardt) Date: 12/26/05 Time: 13:53 Sample(adjusted): 1/01/2001 9/30/2005 Included observations: 1240 after adjusting endpoints Convergence achieved after 113 iterations MA backcast: OFF, Variance backcast: OFF Coefficient C LST(-1)-LST_1(-1) LST(-2)-LST_1(-2) LFT_1-LST_1 LFT_1(-1)-LST_1(-1) MA(1) 0.00025 1.20774 -0.39240 0.21076 -0.17913 -0.34335 Variance C ARCH(1) GARCH(1) R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat Inverted MA Roots 0.00001 0.49898 0.54671 0.70410 0.70217 0.00978 0.11768 4269.69411 1.76153 0.34000 Ω Ω Ω Prob. 0.03438 0.00000 0.00000 0.00000 0.00000 0.00000 Ω Ω Ω Ω Ω

exchange rate are past values in the rate of change of spot exchange rate (dLSt_1), with the coefficient of 0,975.
Table A2.9 GARCH Model: General to Specific
Variables dLSt_1 dLSt_3 dLSt_5 dLSt_6 dLSt_8 dLSt_9 dLSt_10 dLSt_11 dLSt_13 dLSt_15 dLSt_16 dLSt_17 dLSt_20 dLSt_21 dLSt_22 dLSt_23 dLSt_25 dLSt_26 dLSt_27 dLSt_30 Variables dLSt_31 dLSt_32 dLFt alpha_0 alpha_1 beta_1 Coefficient Std.Error robust-SE 0.9753 -0.0118 -0.8409 0.8515 -0.0303 -0.0108 -0.6906 0.6956 -0.0263 -0.5832 0.6581 -0.0853 -0.4562 0.5543 -0.1811 0.0211 -0.2803 0.3974 -0.1444 -0.1489 0.0163 0.0216 0.0273 0.0291 0.0262 0.0223 0.0341 0.0321 0.0203 0.0327 0.0360 0.0235 0.0303 0.0359 0.0280 0.0167 0.0274 0.0323 0.0238 0.0199 0.0249 0.0257 0.0377 0.0412 0.0349 0.0320 0.0525 0.0559 0.0266 0.0589 0.0921 0.0478 0.0633 0.1147 0.0733 0.0245 0.0623 0.1074 0.0596 0.0466 t-value 39.2000 -0.4610 -22.3000 20.7000 -0.8680 -0.3380 -13.1000 12.4000 -0.9880 -9.9100 7.1500 -1.7900 -7.2100 4.8300 -2.4700 0.8610 -4.5000 3.7000 -2.4200 -3.2000 t-value 2.9100 -2.1400 1.4500 2.0000 23.7000 t-prob 0.0000 0.6450 0.0000 0.0000 0.3860 0.7350 0.0000 0.0000 0.3230 0.0000 0.0000 0.0740 0.0000 0.0000 0.0140 0.3890 0.0000 0.0000 0.0150 0.0010 t-prob 0.0040 0.0320 0.1480 0.0460 Ω 0.0000

Std. Error z-Statistic 0.00012 2.11562

0.05110 23.63663 0.04236 0.02884 0.03533 0.06420 Equation 0.00000 12.57865 0.02543 19.61993 0.02316 23.60178 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion F-statistic Prob(F-statistic) -9.26456 7.30821 -5.07055 -5.34847

0.00000 0.00000 0.00000 0.00033 0.01792 -6.87209 -6.83491 366.14286 0.00000

Coefficient Std.Error robust-SE 0.2371 -0.1007 0.0346 0.0000 0.1517 0.8483 0.0244 0.0173 0.0265 0.0000 Ω 0.0815 0.0470 0.0239 0.0000 Ω

6. GARCH Model; General to Specific
Moreover, the GARCH model is employed again by the starting lag which is quite long; in this regard, it is 40 lag. The selection of this optimum lag is based on the theory of reduction, where a insignificant lag is excluded sequentially from the model. Several lags, which are not significant, are still incorporated into the model since they are still relevant. In this model, any changes in forward premium (dLFt) are treated as fixed variable. It is conducted in order to test whether this variable is 1 or not. The estimation result in Table A2.9 indicates again that there is forward premium puzzle since the coefficient of forward premium is just 0,03 and also not significant. The variables which determine the rate of change in spot

log-likelihood 7407.0042 mean(h_t) 0.0005 no. of observations 2331.0000 AIC.T -14762.0084 mean(dLSt) 0.0032 alpha(1)+beta(1) 1

HMSE 21.689 var(h_t) 2.771E-06 no. of parameters 26.000 AIC -6.333 var(dLSt) 0.002 alpha_i+beta_i>=0, alpha(1)+beta(1)<1

7. Autoregressive Distributed Lag (ADL)
The variables that are tested in table A2.9 are in the first-difference form. This is done in order to avoid the possibility of spurious regression. The ADL model enables us to conduct the estimation on the level without worry about spurious regression problem. Therefore, the next estimation employs ADL model then applying the theory of reduction. The estimation results with ADL model could be followed in Table A2.10.

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Table A2.10 Model ADL
Dependent Variable: LST Ω Ω Method: ML - ARCH (Marquardt) Sample(adjusted): 9/16/1996 9/30/2005 Included observations: 2360 after adjusting endpoints Convergence achieved after 362 iterations MA backcast: 9/13/1996, Variance backcast: ON Coefficient C LST_1 LST_1(-1) LST_1(-2) LFT_1 LFT_1(-1) LFT_1(-2) AR(1) MA(1) 0.0079 0.3139 0.2980 0.2648 0.0214 0.0480 0.0530 0.8432 0.2747 Variance C ARCH(1) (RESID<0)*ARCH(1) GARCH(1) R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat Inverted AR Roots Inverted MA Roots 0.0000 0.1233 -0.0832 0.9369 Ω Ω Ω Ω Ω Ω Prob. 0.3043 0.0000 0.0000 0.0000 0.1898 0.0015 0.0000 0.0000 0.0000

of TARCH, which is (RESID<0)*ARCH(1), is not positive significantly, therefore there wont be asymmetric effects. On the other hand, if (RESID<0)*ARCH(1) is positively significant, therefore it indicates that there us a leverage effect in the conditional variance.
Ω

In the application, the value (RESID<0)*ARCH(1),
Std. Error z-Statistic 0.0077 1.0272 0.0052 60.7839 0.0030 100.9150 0.0146 18.1129 0.0163 1.3112 0.0151 3.1783 0.0123 4.3095 0.0116 72.6997 0.0202 13.6077 Equation 0.0000 0.7516 0.0050 24.6745 0.0068 -12.3133 0.0012 764.4719 0.4523 0.0000 0.0000 0.0000 8.9364 0.4496 -6.4495 -6.4178 74502.8338 0.0000

which has negative value in Table A2.10 above, indicates that the volatility decreases. In this regard, if the market agents predict the exchange rate by punishing the market in such away until its prediction is above its actual value, then in the next period, it won»t predict as high as in the previous period. Therefore, it would be stabilization process until the volatilities decreased.

8. The Structural Break Test
The issues about outliers and seasonality are also incorporated into estimation. This condition is conducted by employing the Dummy variable into the model. In this regard, the structural break test is conducted by using Chow test. The estimation result indicates that this model is robust enough and does not involve any structural break (Table A2.11).
Table A2.11 Specific Model of Log Spot Rate
Variables Constant LFT1_18 LFT1_26 LFT1_27 LFT1_29 LST_1 LST_3 LST_4 LST_5 LST_6 LST_7 LST_8 Variables LST_13 Coeff 0.0166 -0.0570 -0.0594 0.0609 -0.0406 1.0326 -0.0925 0.0684 0.0539 -0.0472 0.0555 -0.0603 Coeff 0.0468 -0.0892 0.0432 StdError 0.0050 0.0143 0.0150 0.0148 0.0084 0.0177 0.0191 0.0200 0.0195 0.0192 0.0138 StdError 0.0142 0.0183 0.0159 t-value 3.3130 -3.9800 -3.9520 4.1080 -4.8610 -5.2370 3.5860 2.6970 -2.4210 2.8900 -4.3800 t-value 3.2870 -4.8860 2.7110 t-prob 0.0009 0.0001 0.0001 0.0000 0.0000 0.0000 0.0000 0.0003 0.0070 0.0155 0.0039 0.0000 t-prob 0.0010 0.0000 0.0068

0.9974 Mean dependent var 0.9974 S.D. dependent var 0.0231 Akaike info criterion 1.2483 Schwarz criterion 7623.4501 F-statistic 2.0572 Prob(F-statistic) 0.8400 -0.2700

Based on the Table A2.10, the variables that influence on the rate of change of spot exchange rate are past value of the rate of change from the spot exchange rate. Such condition is described by AR(1) which is significant. Even though LST_1(-1), the value of the logarithm of the spot exchange rate for the previous one week, is incorporated into the model, the coefficient of AR(1) is bigger than LST_1(-1). This situation indicates that the most influential variable on the rate of change of spot exchange rate is the rate of change on the spot exchange rate from the previous one-day. Therefore, this estimation model World gives the same result with the previous estimations. In that model, it s also incorporated the component of threshold (asymmetric) ARCH (TARCH). If the coefficient

0.0101 101.8510

LST_14 LST_15

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Table A2.11 Specific Model of Log Spot Rate (cont.)
Variables LST_17 LST_18 LST_19 LST_24 LST_29 With Dummy OutliersΩ RSS LogLik T R^2 HQ FpNull Chow(1202:1) Chow(2135:1) 0.3008 sigma 10448.0000 AIC 2333.0000 p 0.9993 Radj^2 -8.8053 SC 0.0000 FpGUM value prob 0.2160 1.0000 0.1987 1.0000 0.0116 Ω -8.8826 Ω 86.0000 Ω 0.9993 Ω -8.6704 Ω 0.6140 ΩΩ Ω Coeff -0.0461 0.0829 -0.0453 0.0486 0.0432 StdError 0.0155 0.0183 0.0139 0.0132 0.0102 t-value -2.9660 4.5380 -3.2590 3.6890 4.2520 t-prob 0.0030 0.0000 0.0011 0.0002 0.0000

indicates that the coefficient Ft-1 is close to 1; while the value of the constantan is close to zero. This result is similar to the estimation result by employing VAR model. Therefore, it is concluded that in the long-term, forward exchange rate is not bias.

V. CONCLUSION
The result estimation indicates a possibility of biased forward exchange rate in the short-term. The coefficient β=1 and α=0, therefore, it would create forward premium puzzle. However, in the long-term, forward exchange rate is unbiased predictor for spot exchange rate. Therefore, it concludes that Indonesian forward market is not efficient since the shock is not responded yet instantaneously. The

9. Long Run Coefficient
Table A2.12 Dynamic Analysis Long Run Coefficient
Variable Ft_1 Constant Long-run Coef 1.019 -0.176 SE 0.007 0.062 Ho B=1 B=0 t 2.754 -2.845

Shocks are only responded in the long-term. Realizing that Indonesian forward market is very thin, this is a quite normal result, as exists in other countries such as New Zealand and Russia. Therefore, the role of government is expected to encourage the forward market in order to enable more players in forward market. As a

From the ADL estimation ADL, the long run coefficient Ft-1 on St (Table A2.12) is calculated. That result

result, it would increase the activities in forward market and creating market efficiency.

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References

Ang. James dan Yingmei Cheng. ≈Financial Innovation and Market EfficiencyΔ. Asal, Maher. ≈Are There Trends Towards Efficiency For the Egyptian Stock Market?Δ. School of Economics and Commercial Law, University of Goteborgh, Swedia. Baillie, Richard T. and Rehim Kihc. 2005. ≈Do Asymmetric and Nonlinear Adjusments Explain The Forward Premium AnomalyΔ. Benhard, William dan David Leblang. 1999. ≈Political Processes and Foreign Exchange MarketΔ. Dipresentasikan dalam Annual Meetings of the

Gene D»Avolio, Efigildor dan Andrei Shleifer. September 2001. ≈Technology, Information Production and Market EfficiencyΔ. Harvard Institute of Economic

Research (HIER).
Hayo, Bernd and Ali M.Kutan. 2002. ≈The Impact Of News Oil Prices, And International Spillovers On Russian Financial MarketsΔ. J. Mester, Loretta. 2003. ≈Applying Efficiency Measurement Techniques to Central BanksΔ. Jensen, Michael C. 1978. ≈Some Anomalous Evidence Regarding Market EfficiencyΔ. Journal of Financial

American Political Science Association.
Chinn, Menzie D., and Guy Meredith. 2004. ≈Monetary Policy and Long-Horizon Uncovered Interest ParityΔ. Crowder, William dan Chanwit Phengpis. 2003. ≈Testing Future Market Efficiency using Adaptive EstimationΔ.

Economics, Vo. 6 Nos. 2/3.
Kim, In June, and Jung Seok.ΔCovered Interest Arbitrage and The Currency Crisis in KoreaΔ. Koedijk, Kees G. dan Mack Ott. 1987. ≈Risk Aversion, Efficient Markets and the Forward Exchange RateΔ.

University of Texas at Arlington.
Dimson, Elroy dan Massoud Mussavian. 2000. ≈Market EfficiencyΔ. The Current Business Disciplines, Spellbound Publcation Vol. 3 PP. 959 √ 970. Dow, James. ≈Market EfficiencyΔ. Farmer, J. Doyne dan Andrew W. Lot. 1998. ≈Frontiers of Finance: Evolution and Efficient MarketsΔ. Summary

Federal Reserve Bank of St. Louis
Kristin, Forbes J. 2005. ≈Capital Controls: Mud in the Wheel of Market EfficiencyΔ. Cato Journal Vol. 25 No. 1 Winter 2005. Levi, Maurice D. 1996. The Market and Financial

management of Multinational Business. Third Edition.
Mc Graw Hill. Los Cornelis. ≈Measuring the Degree of Efficiency of Financial Market Efficiency: An EssayΔ. Lothian, James R., and Liuren Wu. 2003. ≈Uncovered Interest Rate Parity Over The Past Two CenturiesΔ. Malkiel, Burton G. 2003. «The Efficient Market Hypothesis and Its CriticsΔ. Olsen, Richard B., et. al. 1992. ≈Going Back to the BasicsRethingking Market EfficiencyΔ.

of a Session Presented in Annual Symposium aon Frontiers of Science.
Financial Market Efficiency and Its Implications Financial Markets in Central and East European Countries Before Accession to the EU, Deutsche Bundesbank Monthly Report, July 2003. Fisher, Eric O»N. 2001. ≈Purchasing Power Parity and Interest Parity in The LaboratoryΔ.

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Overviw of Forcasting Models. Pedersen, Lasse H. ≈Market Efficiency and AnomaliesΔ. Presentation. Seiler, Michael J. dan Walter Rom. 1997. ≈A Historical Analysis of Market Efficiency: Do Historical Returns Follow a Random Walk?Δ. Journal of

Tas, Oktay dan Salim Dursunoglu. 2005. ≈Testing Random Walk Hypothesis For Instanbul Stock ExchangeΔ. International Trade and Finance Association 15th International Conference. Thornton, Daniel L.. 1982. ≈The Discount Rates and Market Interest RatesΔ. Woodford, Michael. 2002. ≈Financial Market Efficiency and The Effectiveness of Monetary PolicyΔ.

Financial and Strategic Decisions Vol. 10, No. 2,
Summer 1997

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Glossary, Abbreviation, Appendix

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28a

Glossary, Abbreviation, Appendix

Glossary

Bearish

:

A market has a bearish trend when prices are falling in a prolonged period of time

Bullish Bubble

: :

The opposite situation of bearish market A situation in which a wave of public enthusiasm causes an exaggerated bull market. When such a bubble takes place, market price of asset (listed stocks, property or other securities) rise dramatically, making them significantly overvalued by any measure of stock valuation. Generally asset market bubbles are followed by market crashes.

Capital Adequacy Ratio

:

The ratio of a bank»s capital to its risk-weighted credit exposure. International standards recommend a minimum for this ratio, intended to permit banks to absorb losses without becoming insolvent, in order to protect depositors.

Capital Outflow

:

A net flow of capital, real and/or financial, out of a country, in the form of reduced holdings of domestic assets by foreigners and/or increased purchases of foreign assets by domestic residents. Recorded as negative, or a debit, in the balance on capital account.

Competitive Advantage

:

Competitive advantage is a position attained by a firm when it occupies in its competitive position. Competitive advantage is attained when a company makes economic earnings exceeding their costs (including cost of capital). This means that normal competitive pressures are not able to drive down the firm»s earnings to the point where they cover all costs and just provide minimum sufficient additional return to keep capital invested.

Contingency Plan

:

A plan involving suitable backups, immediate actions and longer term measures for responding to computer emergencies such as operational failure, for backup procedures, disaster recovery. It is also plans maintained for emergency response, backup operations, and postdisaster recovery for an information system, to ensure the availability of critical resources and to facilitate the continuity of operations in an emergency situation.

Debt Swap

:

Transaction involving exchanges existing bonds (or other debt

29a

Glossary, Abbreviation, Appendix

instruments) for newly issued stock (equity). A debt-equity swap can help a company that is in financial trouble by canceling some of its outstanding debt. Disaster Recovery Center : Preventative measures using redundant hardware, software, data centers and other facilities to ensure that a business can continue operations during a natural or man-made disaster and if not, to restore business operations as quickly as possible when the calamity has passed. Downsizing : Employee reassignment, layoffs and restructuring in order to make a business more competitive, efficient, and/or cost-effective Emerging Countries : The markets of countries which have a low per head income compared with the developed world. Emerging markets attract because the potential for rapid economic growth in emerging market countries is better than in more mature markets. However, the risks, both economic and political, are high. Good Corporate Governance : The set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled. Corporate governance also includes the relationships among the many players involved (the stakeholders) and the goals for which the corporation is governed. Financial Deepening : Financial deepening refers to the increased provision of financial services with a wider choice of services geared to all levels of society. Hedge Fund : A hedge fund is a private investment fund charging a performance fee and typically open to only a limited number of investors, e.g., those in the United States, hedge funds are largely open to limited investors only. Hedge funds are not currently subject to any direct regulation by the SEC, the NASD, or other federal regulating commissions, unlike mutual funds, pension funds, and insurance companies. Niche Market : A niche market is a focused, targetable portion (subset) of a market sector. By definition, then, a business that focuses on a niche market is addressing a need for a product or service that is not being addressed by mainstream providers. A niche market may be thought of as a narrowly defined group of potential customers. Non Performing Loans (NPLs) : Loans that are in default or close to being in default.

30a

Glossary, Abbreviation, Appendix

Risk-Based Supervision

:

The risk based supervision approach entails the monitoring of banks by allocating supervisory resources and focusing supervisory attention according to the risk profile of each institution. The instruments of risk based supervision will be by way of enhancements of the supervisory tools traditionally used, viz., off-site monitoring and on-site examination supplemented by a market intelligence mechanism.

Wealth Effect

:

An increase in spending that accompanies an increase in \o ≈WealthΔ wealth

31a

Glossary, Abbreviation, Appendix

Abbreviation

ARO ATM BoP CAR CIB CIS DCS DER DIS DRC ER FSN GCG GDP IBA IDI IDIC IFSD IPO JCI LDR MSME NAV NCD NII NOP NPL ORI ROA ROE

: Automatic Roll Over : Anjungan Tunai Mandiri : Balance of Payment : Capital Adequacy Ratio : Credit Information Bureau : Credit Information System : Direct Cash Subsidy : Debt to Equity Ratio : Debtor Information System : Disaster Recovery Center : Efficiency Ratio : Financial Safety Nets : Good Corporate Governance : Gross Domestic Product : Indonesian Banking Architecture : Individual Debtor Information : Indonesia Deposit Insurance Corporation : Information System of Funding Provision : Initial Public Offering : Jakarta Composite Index : Loan to Deposit Ratio : Micro Small and Medium Enterprises : Net Asset Value : Non Core Deposit : Net Interest Income : Net Open Position : Non Performing Loan : Obligasi Ritel Indonesia : Return on Asset : Return on Equity

32a

Glossary, Abbreviation, Appendix

RTGS RWA SBI SKNBI SUN

: Real Time Gross Settlement : Risk Weighted Asset : Sertifikat Bank Indonesia : Sistem Kliring Nasional Bank Indonesia : Surat Utang Negara

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Glossary, Abbreviation, Appendix

Table - Appendix 1 Banking Key Indicators
Period 2002 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Total Assets 1,042.13 1,086.44 1,064.60 1,056.45 1,053.44 1,048.06 1,072.55 1,077.41 1,092.50 1,104.30 1,095.79 1,112.20 1,117.80 1,105.14 1,099.96 1,106.88 1,102.89 1,111.68 1,113.64 1,119.07 1,130.40 1,147.89 1,141.00 1,196.24 1,157.15 1,152.73 1,149.95 1,145.25 1,179.43 1,185.70 1,182.79 1,208.17 1,213.09 1,218.35 1,228.10 1,272.28 1,258.39 1,262.63 1,280.57 1,312.75 1.324.74 1,344.60 1,353.19 1,346.61 1,418.62 1,420.29 1,428.08 1,469.83 1,465.64 1,466.34 1,465.30 1,466.92 1,514.92 1,519.44 Credits 351.50 351.82 350.59 350.12 346.91 357.43 369.05 377.04 387.69 394.27 402.18 410.29 402.57 411.18 420.52 426.22 427.97 434.10 441.06 447.23 454.17 463.68 475.66 477.19 475.03 477.30 485.91 496.07 513.42 528.68 530.18 547.53 555.06 567.26 573.36 595.06 590.72 601.82 617.79 629.68 650.78 664.30 677.61 702.22 715.28 719.86 722.44 730.16 714.22 714.69 722.74 733.43 747.58 757.35 Deposits 791.91 789.43 783.36 785.05 787.01 791.06 808.80 811.16 814.97 821.53 815.36 835.78 824.65 832.02 833.41 837.84 838.11 846.78 852.16 858.03 863.40 879.40 875.42 888.60 886.46 877.09 875.13 872.91 895.12 912.79 909.47 919.25 926.43 928.11 932.50 963.11 950.06 948.83 959.25 978.62 986.74 1.011.01 1.015.99 1.046.82 1.077.54 1.071.10 1.091.33 1.127.94 1.116.19 1.123.69 1.123.87 1.123.16 1.160.61 1.168.25 Earning Assets 1.042.47 1.035.17 1.022.70 1.020.70 1.016.23 1.013.19 1.039.03 1.041.00 1.049.73 1.053.60 1.041.15 1.023.60 1.034.30 1.044.80 1.052.90 1.051.40 1.042.50 1.052.20 1.062.75 1.057.70 1.066.70 1.077.90 1.064.00 1.072.40 1.074.93 1.080.50 1.080.33 1.075.14 1.093.37 1.102.78 1.087.66 1.110.75 1.074.71 1.127.77 1.114.95 1.146.83 1.147.29 1.156.61 1.128.41 1.207.65 1.222.41 1.239.93 1.257.73 1.290.53 1.283.34 1.279.54 1.283.30 1.353.21 1.354.52 1.346.15 1.346.59 1.360.64 1.400.54 1.405.96

Trillions of Rp Net Interest Income 3.30 3.21 3.42 3.38 3.35 3.55 3.66 3.82 3.71 3.65 3.85 4.01 3.78 3.63 3.95 3.96 3.93 4.12 4.39 4.48 4.69 4.47 4.90 3.20 5.25 5.08 5.66 5.35 5.29 5.41 5.37 5.31 5.31 6.40 5.02 6.32 5.81 5.43 5.99 5.96 5.57 6.13 5.72 6.04 5.90 6.00 6.17 6.22 6.90 5.60 6.82 6.49 7.17 7.58

2003

2004

2005

2006

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Glossary, Abbreviation, Appendix

Table - Appendix 2 Key Indicators of Multi Finance Companies
Financing Amount 15,623,442 30,697,389 30,326,515 30,431,436 30,440,907 31,142,647 31,481,849 32,263,648 32,946,620 33,331,760 33,267,621 32,938,949 32,979,169 32,829,258 31,011,949 33,303,991 33,495,759 34,599,934 36,179,693 36,079,019 37,072,526 38,615,465 39,688,224 38,386,223 40,616,426 41,306,912 43,789,745 44,211,281 45,943,843 47,939,833 48,813,559 49,781,802 49,926,060 53,307,707 54,479,821 55,753,031 55,822,974 57,638,201 59,263,126 60,829,807 59,864,976 64,168,381 66,113,680 67,702,266 67,702,266 68,221,489 67,443,676 67,646,734 66,844,223 65,708,529 64,870,643 65,487,852 66,789,425 68,201,883 Current Liabilities 825,002 1,616,754 1,632,855 1,626,587 1,800,165 1,965,286 1,896,363 1,929,989 1,928,571 1,942,874 2,024,035 2,086,276 2,043,991 2,268,475 1,461,818 2,128,351 2,177,168 2,303,616 2,328,708 2,278,684 2,349,824 2,029,741 1,861,639 1,141,633 1,913,262 1,376,444 2,090,052 1,883,949 1,920,998 2,013,740 2,055,190 2,175,215 2,107,179 2,305,539 2,198,896 2,323,800 2,396,475 2,347,439 2,395,036 2,383,116 2,501,725 2,932,585 3,067,969 2,662,812 2,718,988 2,469,350 2,401,562 2,480,054 2,016,302 2,101,404 1,941,163 2,209,401 1,733,501 1,699,523 On Shore Liabilities 12,344,428 17,458,489 17,172,177 17,328,451 17,432,047 17,056,838 17,455,779 17,776,589 18,042,553 18,039,650 17,593,247 16,615,726 16,362,436 16,391,746 13,615,445 16,346,185 15,590,878 15,930,444 16,589,037 16,472,976 16,646,349 17,127,971 17,783,741 15,633,119 17,720,248 16,258,604 18,030,256 17,716,796 18,777,519 20,027,191 20,358,809 21,298,497 21,755,980 22,556,282 22,493,852 23,951,479 23,107,640 23,240,433 24,544,118 24,663,125 25,117,762 26,190,619 28,039,150 29,489,168 29,489,168 29,144,575 28,935,212 29,503,054 29,019,441 27,495,880 27,550,936 27,144,550 27,854,449 27,128,551 Off Shore Liabilities 4,527,869 11,237,392 10,409,834 10,018,803 9,019,175 9,629,097 10,040,435 9,913,796 9,896,032 10,103,689 9,776,885 9,794,781 9,751,022 9,700,099 9,917,301 9,559,602 9,125,517 9,006,324 11,644,034 11,143,451 11,778,433 12,038,187 11,955,673 11,688,392 12,625,854 13,257,433 14,084,379 14,134,521 17,025,930 18,000,304 17,550,821 19,351,608 19,665,735 21,526,613 22,710,039 22,969,003 23,466,301 24,839,796 24,745,033 25,991,791 25,091,604 26,057,043 27,349,112 29,006,200 29,603,478 29,983,952 31,474,348 31,305,050 30,521,664 30,664,698 30,010,949 30,125,792 32,016,633 31,891,260 Subordinated Loans 508,660 2,019,053 1,983,866 2,018,329 1,928,227 1,891,852 1,983,870 1,932,952 1,923,246 2,007,575 2,007,860 1,974,889 2,009,823 2,014,849 2,002,213 2,314,212 1,939,099 1,933,575 1,967,976 1,970,407 1,688,960 1,704,654 1,792,090 1,932,805 1,885,432 1,885,546 1,898,598 1,826,846 1,927,854 1,924,222 2,276,476 2,074,503 2,130,472 2,097,092 2,101,520 2,158,183 2,119,916 1,321,625 2,223,494 2,234,106 2,218,547 2,273,498 1,547,447 1,554,018 1,554,018 1,536,605 355,934 358,453 153,257 154,380 152,878 145,853 151,167 146,120

Millions of Rp Bonds Capital

Period

2002

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

√ 746,438 746,597 746,957 1,122,901 1,423,963 1,424,565 1,425,168 1,725,770 1,719,181 1,678,995 1,676,809 1,642,058 1,643,092 1,344,124 1,344,888 2,716,153 2,700,111 2,899,223 3,396,464 3,375,734 3,556,619 4,000,489 4,003,093 3,989,726 4,921,270 6,431,529 6,915,734 6,481,879 6,809,129 6,789,449 6,512,670 6,910,873 8,850,107 8,785,520 8,861,444 9,844,906 10,762,861 10,442,356 10,828,055 9,879,550 11,410,168 11,621,463 11,415,892 10,809,675 10,416,697 10,219,178 10,171,490 9,673,961 9,508,380 10,342,049 10,740,741 10,336,417 12,386,364

3,424,238 6,897,839 6,976,972 6,980,137 6,967,312 7,043,242 6,879,451 7,113,087 7,268,456 7,596,971 8,532,375 8,570,361 8,727,794 8,775,364 8,729,636 9,367,443 9,457,917 8,876,622 9,031,278 8,957,974 9,061,156 9,138,407 9,009,298 9,026,329 9,581,229 9,963,667 10,318,841 10,156,847 10,282,204 10,379,378 10,322,807 10,347,518 10,465,181 10,575,232 10,613,569 11,032,370 10,943,456 11,013,741 11,069,118 11,108,723 11,162,620 11,525,673 11,629,819 11,252,270 11,619,922 11,541,151 11,791,744 11,877,424 1,2165,632 12,292,602 13,023,882 13,020,999 13,595,480 13,677,109

2003

2004

2005

2006

35a

Glossary, Abbreviation, Appendix

Table - Appendix 3 Indicators of Equity Market
Period 2002 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jakarta Composite Index 451.64 453.25 481.78 534.06 530.79 505.01 463.67 443.67 419.31 369.04 390.43 424.95 388.44 399.22 398.00 450.86 494.78 505.50 507.99 529.68 597.65 625.55 617.08 691.90 752.93 761.08 735.68 783.41 732.52 732.40 756.98 754.70 820.13 860.49 977.77 1,000.23 1,045.44 1,073.83 1,080.17 1,029.61 1,088.17 1,122.38 1,182.30 1,050.09 1,079.28 1,066.22 1,096.64 1,162.64 1,232.32 1,230.66 1,322.97 1,464.41 1,330.00 1,310.26 Capitalization (Trillions of Rp) 272.88 282.49 318.70 344.78 332.60 315.76 285.40 276.31 260.23 234.52 246.74 268.78 238.59 250.86 251.58 284.29 320.72 339.73 345.73 356.54 396.02 407.31 411.67 460.37 501.17 509.31 492.51 529.81 493.27 495.80 514.61 514.19 558.76 585.93 667.42 679.95 710.37 731.36 735.81 701.83 740.30 765.81 805.45 721.22 757.45 740.69 758.38 801.25 846.54 850.96 910.56 1,003.76 914.91 901.02 Foreign Investors Transactions (Trillions of Rp) 0.473 -0.223 0.232 0.404 0.033 -0.053 1.001 0.083 0.875 0.324 -0.017 4.780 0.152 -0.002 0.008 0.010 0.001 0.060 1.488 0.103 2.125 2.382 0.999 2.551 1.827 2.459 2.117 1.694 -0.325 0.108 0.849 0.177 2.223 1.300 4.262 2.147 2.006 0.634 -19.070 0.798 -17.986 2.344 2.064 2.899 3.228 5.878 0.541 1.284 2.192 0.685 1.936 3.042 0.719 -0.606

2003

2004

2005

2006

36a

Glossary, Abbreviation, Appendix

Table - Appendix 4 Indicators of Bond Market
Corporate Bonds Period Listed Bonds 18,830.91 18,830.91 18,199.31 18,518.31 19,068.31 19,406.64 20,028.29 19,681.12 20,431.12 20,271.26 20,944.72 21,520.58 22,228.12 22,228.12 22,339.62 22,704.49 23,758.49 28,392.28 35,842.03 35,863.03 35,963.03 39,584.03 39,824.03 45,599.03 45,606.21 45,528.73 47,319.79 48,239.64 49,250.66 50,486.62 53,613.50 53,335.02 53,652.76 57,013.82 58,620.45 61,800.20 58,363.24 59,457.16 58,379.69 59,123.56 59,171.99 61,390.15 65,524.07 63,770.94 63,570.94 63,295.94 63,230.94 62,830.94 62,955.94 62,630.94 63,435.64 61,935.64 63,780.64 63,066.66 Volume 144.90 152.00 65.78 630.77 366.12 510.69 649.26 660.00 1,052.24 1,330.63 381.22 148.12 513.92 640.55 389.49 391.00 896.00 2,943.35 3,418.85 957.64 660.79 865.65 1,255.87 1,420.26 1,256.76 1,131.53 1,862.68 2,027.03 1,301.29 979.78 1,359.94 1,323.52 1,375.05 1,572.05 1,363.40 1,794.28 3,383.50 1,117.63 1,553.45 3,743.95 871.25 969.43 1,328.10 1,665.97 3,424.48 3,517.45 1,025.88 4,497.30 1,457.69 1,988.92 921.35 907.22 655.40 934.55 Government Bonds Listed Bonds 64,772.23 68,772.23 71,821.15 72,559.90 74,418.90 111,485.33 109,220.80 113,820.51 118,199.32 120,192.62 224,176.73 397,967.17 397,967.17 397,987.37 388,499.54 390,746.34 391,238.29 385,036.84 385,036.84 385,036.84 385,036.84 385,036.84 385,036.84 389,909.79 384,655.48 384,655.48 388,342.60 392,609.51 384,885.22 385,513.39 386,586.54 394,386.98 391,250.06 400,624.91 401,164.79 399,304.20 404,767.83 408,236.43 408,714.40 409,249.03 400,186.96 404,985.12 404,985.12 404,985.12 406,545.12 405,466.12 401,416.31 389,507.56 405,709.31 395,711.88 399,962.13 403,212.13 404,512.13 407,292.96

Millions of Rp

Volume 6,459.96 10,562.98 8,448.65 3,721.35 10,460.72 9,035.66 14,186.15 17,302.75 16,688.59 12,264.51 10,563.02 11,092.92 17,597.60 17,368.72 17,456.94 21,506.16 29,635.75 45,609.81 7,347.41 5,000.48 6,558.29 11,245.57 7,379.00 3,752.25 59,424.49 48,159.98 51,666.44 42,196.74 40,480.53 32,812.21 41,258.20 42,824.18 37,916.24 30,116.28 38,090.52 48,042.86 58,513.84 44,953.79 56,643.47 76,050.59 41,569.09 39,843.48 8,277.70 7,478.03 15,341.36 7,354.02 896.81 7,548.31 3,263.04 2,722.09 3,023.57 1,929.08 1,896.31 5,322.53

2002

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

2003

2004

2005

2006

37a

Glossary, Abbreviation, Appendix

Table - Appendix 5 Indicators of Mutual Funds
Period 2002 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Net Asset Value 8.53 11.54 13.89 14.80 16.50 17.89 24.59 29.93 35.69 41.02 44.35 46.61 15.27 16.36 16.20 15.85 16.18 17.11 18.94 20.00 21.66 22.76 25.00 67.36 69.98 73.73 76.04 81.40 83.54 84.71 89.29 92.03 94.47 98.37 101.23 100.99 108.22 110.78 102.29 83.59 82.02 80.17 76.12 62.97 31.56 31.29 29.57 28.39 27.60 26.20 28.11 28.92 29.74 33.06 Fixed Income 4.91 7.81 9.78 10.35 11.50 12.69 18.98 23.82 28.88 33.04 35.40 37.34 42.08 44.98 47.79 50.10 53.95 58.13 66.82 70.97 75.12 67.21 60.60 57.48 57.67 60.94 64.62 69.47 70.63 71.02 74.32 76.88 79.51 83.26 85.98 85.04 90.99 92.24 78.91 57.19 56.05 55.14 50.24 39.17 16.45 14.79 13.45 12.97 13.46 13.69 13.4 14.31 13.79 13.26

Trillions of Rp Equity 0.54 0.52 0.54 0.59 0.60 0.58 0.56 0.54 0.28 0.26 0.27 0.30 0.25 0.26 0.24 0.26 0.29 0.30 0.28 0.27 0.29 0.39 0.39 0.40 0.48 0.51 0.49 0.54 0.65 0.71 0.77 0.87 1.02 1.22 1.61 1.89 2.27 2.95 4.53 4.59 5.05 5.03 5.36 5.78 5.79 5.39 5.33 4.93 4.26 4.16 3.91 4.01 4.61 4.71

2003

2004

2005

2006

38a

Glossary, Abbreviation, Appendix

Table - Appendix 6.A Indicators of Corporate Sector
Business Prospect in 3 Months (%, net balance) 13.71 17.02 21.00 18.39 12.76 14.43 20.53 25.65 17.52 24.88 27.62 33.65 21.24 23.80 20.34 16.30 15.43 17.76 Expectation of Business Prospect in 6 Months to Come (%, net balance) 43.03 41.00 32.04 29.06 29.17 31.01 32.25 28.59 33.28 34.12 35.54 43.27 40.84 39.09 24.36 31.46 36.65 36.77 Expectation of Sales Price (% SBT) 12.88 24.22 26.91 12.19 19.51 13.30 5.06 9.55 11.61 10.85 11.79 12.06 23.16 28.80 22.18 44.76 23.44 15.78

Period

Earning Before Tax (Millions of Rp) 112.27 227.67 345.42 455.66 84.01 206.85 251.07 236.84 74.66 135.31 272.53 375.56 101.56 216.57 333.50 262.43 130.83 NA

2002

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

2003

2004

2005

2006

39a

Glossary, Abbreviation, Appendix

Table - Appendix 6.B Indicators of Corporate Sector
Estimation of Commercial Price in 6 Months to Come (% SBT) 135.75 125.23 134.86 134.70 124.42 122.48 129.38 130.84 107.42 115.28 111.50 111.95 115.60 118.50 117.05 123.29 128.50 123.26 119.91 117.29 118.52 118.32 131.31 119.16 127.86 135.16 133.58 133.85 137.55 136.96 138.33 146.91 135.25 121.48 121.07 119.78 130.74 132.81 140.54 131.80 130.94 139.22 Estimation of Commercial Price in 3 Months to Come (% SBT) 143.69 125.11 129.09 134.39 120.09 119.11 119.35 125.79 115.44 128.57 122.30 116.74 123.80 120.96 117.49 121.62 125.68 117.12 122.02 134.72 138.07 132.02 144.19 135.81 137.08 147.92 131.13 122.48 128.79 136.64 132.38 167.48 156.79 135.21 125.10 123.08 138.95 121.79 125.84 115.36 123.45 127.12

Period

2003

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

2004

2005

2006

40a

Glossary, Abbreviation, Appendix

Table - Appendix 7 Household Indicators
Period 2002 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Current Economy 63.71 56.53 63.19 61.75 63.75 64.36 68.08 67.49 68.47 66.20 63.75 64.01 52.03 55.51 56.00 64.10 68.80 66.20 71.50 67.40 71.00 71.80 72.00 73.70 74.50 74.40 71.60 73.30 74.61 74.52 78.86 80.46 81.07 88.88 97.32 101.79 91.89 90.30 79.78 75.13 84.25 87.19 86.59 84.85 78.32 64.44 68.80 71.94 74.26 74.96 78.42 73.08 74.14 76.81 Consumer Expectation 81.56 75.53 84.79 85.12 83.26 93.60 93.90 88.22 89.83 85.69 81.33 83.68 64.28 73.62 75.20 79.80 87.90 88.40 92.20 85.20 88.40 90.00 92.10 92.20 91.30 92.70 93.20 108.00 108.41 110.23 118.02 116.39 120.25 139.54 143.44 136.35 122.56 119.89 103.82 101.74 110.85 116.22 111.16 114.49 101.80 89.43 91.91 101.24 102.61 95.19 103.33 102.67 102.17 105.42 Consumer Confidence Index 72.63 66.03 73.99 73.43 73.51 78.98 80.99 77.86 79.15 75.94 72.54 73.84 58.15 64.57 65.60 72.00 78.40 77.30 81.80 76.30 79.70 80.90 82.10 82.90 82.90 83.50 82.40 90.70 91.51 92.38 98.44 98.43 100.66 114.21 120.38 119.07 107.22 105.10 91.80 88.43 97.55 101.70 98.87 99.67 90.06 76.94 80.36 86.59 88.44 85.08 90.87 87.88 88.16 91.12

2003

2004

2005

2006

41a

Glossary, Abbreviation, Appendix

Table - Appendix 8 Indicators of Macroeconomy

Period

SBI, 1 Month (%) 16.93 16.86 16.76 16.61 15.51 15.11 14.93 14.35 13.22 13.10 13.06 12.93 12.69 12.24 11.40 11.06 10.44 9.53 9.10 8.91 8.66 8.48 8.49 8.31 7.86 7.70 7.42 7.33 7.32 7.34 7.36 7.37 7.39 7.41 7.41 7.43 7.42 7.43 7.44 7.70 7.95 8.25 8.49 9.51 10.00 11.00 12.25 12.75 12.92 12.92 12.73 12.74 12.50 12.25

Inflation Rate (%) 14.42 15.13 14.08 13.30 12.93 11.48 10.05 10.60 10.48 10.33 10.48 10.03 8.74 7.34 7.12 7.54 6.91 6.62 5.79 6.38 6.20 6.22 5.33 5.06 4.82 4.60 5.11 5.92 6.47 6.83 7.20 6.67 6.27 6.22 6.18 6.42 7.32 7.15 8.81 8.12 7.4 7.42 7.84 8.33 9.06 17.89 18.38 17.11 17.03 17.92 15.74 15.4 15.6 15.53

BI Rate (%) 8.5 9.5 10 11 12.25 12.75 12.75 12.75 12.75 12.75 12.5 12.5

USD Exchange Rate (Rp) 10,313 10,151 9,825 9,330 8,830 8,713 9.065 8,855 9.000 9,215 8,978 8,950 8,870 8,884 8,902 8,675 8,310 8,275 8,510 8,485 8,395 8,497 8,505 8,420 8,457 8,453 8,564 8,705 9,268 9,400 9,130 9,370 9,155 9,088 9,000 9,270 9,161 9,285 9,465 9,570 9,518 9,760 9,805 10,300 10,300 10,123 10,025 9,830 9,370 9,183 9,070 8,785 9,255 9,263

2002

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

2003

2004

2005

2006

42a

Glossary, Abbreviation, Appendix

Matrix of Financial Sector Policy Package
I. FINANCIAL SYSTEM STABILITY

II. BANKING INSTITUTIONS III. NON BANK FINANCIAL INSTITUTIONS IV. CAPITAL MARKET V. OTHERS

43a

44a
Program Action Deadline Authority In Charge Dec-06 Ministry of Finance and Bank Indonesia Ministry of Finance, Bank Indonesia, and Deposit Insurance Corporation Ministry of Finance, Bank Indonesia, and Deposit Insurance Corporation Ministry of Finance, Bank Indonesia, and Deposit Insurance Corporation Nov-06 Ministry of Finance and Bank Indonesia Completion of Financial Safety Net Law 1. Completion of Indonesian Financial Sector Archtecture (IFSA) Mar-07 2. Assesment of Pre FSAP Dec-07 Financial Safety Net Law
Glossary, Abbreviation, Appendix

I.

FINANCIAL SYSTEM STABILITY

No.

Policy

1

Strengthening Coordination in Financial Sector 1. Formation of comprehensive financial sector development framework

2

Commencement of the Financial Stability Forum

3. Preparation of Early Warning System for financial sector

Nov-06 - onwards

2. Harmonisation of regulations among authorities 1. Harmonsation of regulations concerning information of asset quality submitted to public 2. Harmonisation of regulations concerning insurance and capital market

Oct-06

Ministry of Finance

II.
Program Action Deadline Authority In Charge Dec-06 Bank Indonesia Expand certification program for bankers Implementation of minimum standard of GCG Aug-06 Bank Indonesia 1. Human Resources Development

BANKING SECTOR

No.

Policy

1

Bolstering banking institutions

2. Enforcement of good corporate governance and risk management 3. Boosting credit quality accepted by international standard Jul-07

Bank Indonesia

1. Conduct evaluation on information system and establish code of conduct in relation to the operations commencement of Credit Bureau 2. Expand the scope of information and access of Credit Bureau Dec-06 - onwards Nov-06 Nov-06

Bank Indonesia

4. Boosting efficiency dna effectiveness of banking supervision and regulation 1. Enhance risk-based supervision methodology 2. Conduct consolidated risk-based supervision

Bank Indonesia Bank Indonesia

5. Customer protection and empowerment

Sep-06 Nov-06 Nov-06 Sep-06

Bank Indonesia Bank Indonesia Bank Indonesia Deposit Insurance Corporation

1. Enhance transparency of banking product information 2. Implementation of standard procedure for customer complaints 3. Establish independent mediation agency 4. Issue regulations to enhance capability of Deposit Insurance Corpoation in handling systemic bank failure

6. Improve instituion and market infrastructure

Oct-06 Nov-06

Bank Indonesia and MOF Bank Indonesia

1. Provide icentives for merger and consolidation 2. Lower the requirement for operning branches of rural and Islamic rural banks

2 Settlements of impaired loans of state-owned banks

Improve state-owned bank performance

Jul-06 Jul-06 Aug-06

Ministry of Finance and Ministry of State Owned Enterprise Ministry of Finance of State Owned Enterprise Ministry of Finance and Ministry of State Owned Enterprise Aug-06 Ministry of State Owned Enterprise

1. Amending the government rules No. 14/2005 2. Amending the Ministry Of Finance Decree No. 31/PMK.07/2005 3. Special supervision over the state-owned banks to boost their governance and performance 4. Ensure commitments of the management of state-owned banks to boost governacem risk management and reducing impaired loans

Glossary, Abbreviation, Appendix

45a

46a
Program Action Deadline Authority In Charge Aug-06 Ministry of Finance Amendment the Ministry of Finance Decree No. 45/KMK.06/2003 of implementation of "know your customer" on non bank financial institution Sept 2006-onwards Ministry of Finance Improve regulation of "know your customer" on non-banking financial institution (anti money laundering program)
Glossary, Abbreviation, Appendix

III. NON BANKING FINANCIAL INSTITUTION

No.

Policy

1

Enforcement of principle of "Know Your Customer" to non-banking financial institution

2

strengthening non bank financial institution 1. Management of unhealthy insurance companies Aug-06 Nov 2006 - onwards Mar-07 Dec-06 Sep-06

Consumer protection and empowerment

3

Strengthening insurance industry

Ministry of Finance

2. Improve the quality and efectivity of insurance regulation and supervisory 3. Protection of insurance holder

Ministry of Finance Ministry of Finance Ministry of Finance Ministry of Finance

4. Enhance the quality of directors and comissioners as well as market player 5. Tax incentive for developer of insurance industry Acknowledgement of claim paid by life insurance as a subtractable fee from

Enhance transparency on non bank financial institution products information Develop strategy management for unhealthy insurance companies, incl. clear and consistent exit policy Implementation of exit policy Enhance the amendment of UU No. 2/1992 on insurance activities Second amendment on government rules No.73/1992 Encourage implementation of mediation agency in insurance industry Implementation of Fit and Proper Test for Directors and Comissioners of insurance companies Dec 2006-onwards

Ministry of Finance

4

Strengthening pension fund industry

Sep 2006-onwards Dec-06 Dec-06

Ministry of Finance Ministry of Finance Ministry of Finance

1. Development of pension fund industry 2. Enhancement of regulation and supervision quality

Prepare road map of pension fund industry 1. Prepare GCG for pension fund industry 2. Issue regulation concerning reporting and supervising pension fund for civil servants Strengtening capital structure, quality of supervision and examination of multi finance companies Strengtening capital structure, quality of supervision and examination of venture capital companies

5

Strengthening multi finance industry

1. Strengthening multi finance industry

Sep-06

Ministry of Finance

2. Strengthening venture capital industry

Oct-06

Ministry of Finance

IV. CAPITAL MARKET
Program Action Deadline Authority In Charge Oct-06 Ministry of Finance 1. Merging JSE and SSE 2. Implement remote trading Enhance the regulation of capital market according to the ROSC Implement e-reporting, e-licensing, e-registration, and e-monitoring Jun-07 Sep-06 Nov-06 Dec-06 Aug-06 Oct 2006 - onwards Oct-06 Ministry of Finance 1. Boost competitiveness and efficiency of the bourses 2. Enhancing quality of supervision and regulation 3. Improve the application of ICT in the capital market 4. Develop secondary markets of debt securities

No.

Policy

1

Development of Capital Markets

Ministry of Finance

Ministry of Finance Ministry of Finance Bank Indonesia Ministry of Finance Ministry of Finance and Bank Indonesia

1. Develop price discovery mechanism 2. Enhance ETP 3. Develop bond repo market 4. Establish primary delers for government bonds 5. Strengthen infrastructure for government bond market Develop Exchange Traded Funds Dec-06

5. Develop collective investment based products 6. Develop legal frameworkd for facilitating Islamic capital markets 1. Regulating the implementation of syariah-based prinsiple in the capital market 2. Setting up the accounting principles in the lights of the implementation of syariah based principle in the capital market Elimination of obligatory fical letter for companies planning to issu bonds and stocks

Ministry of Finance

Dec-06

Ministry of Finance

Dec-06

Ministry of Finance

7. Tax incentives for development of capital markets

Aug-06

Ministry of Finance

2.

Development of government bond markets

Expanding the base of investors

Aug-06 Oct-06

Ministry of Finance Ministry of Finance

1. Issuance of retail government bonds 2. Issuance of syariah based instruments

3.

Strengthening mutual fund industry

Enhacement of accountabilty and supervision

Aug-06

Ministry of Finance

Glossary, Abbreviation, Appendix

1. Improvement of regulations concenring selling agent of mutual funds 2. Setting the regulations concerning selling agent of mutual funds

Aug-06

Ministry of Finance

47a

48a
Program Action Deadline Authority In Charge Dec-06 Ministry of Finance Setting the draft law concerning the Export Financing Agency 1. Establishment of Privatisation Committee 2. Development of privatisation strategy for short and medium term Nov-06 Aug-06 1. Establishment of Export Financing Agency Development of institutional structure for privatisation
Glossary, Abbreviation, Appendix

V.

OTHERS

No.

Policy

1

Development of Export Financing

2.

Privatisation of state owned companies

Coordinating Minister of Economy

Ministry of State Owned Enterprise

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