ANALYSIS-Indonesian reform fought on Bank Century battlefield

By Reuters Staff
March 1, 2010

By Sara Webb and Sunanda Creagh

JAKARTA, March 1 (Reuters) – Indonesia’s Bank Century inquiry has little to do with banking — it is just the latest battleground in a war between reformers and traditional business elites that will decide the fate of two key pro-market allies of the president.

The outcome of this particular battle is crucial for foreign investors and Indonesians alike when it comes to pushing ahead with much-needed reforms and generating a faster pace of growth in southeast Asia’s biggest economy.

If Finance Minister Sri Mulyani Indrawati and Vice President Boediono, the two technocrats in question, remain in their posts, then prospects for reform should improve, and President Susilo Bambang Yudhoyono will have more clout to tackle graft and take on the overhaul of the civil service, police and judiciary.

But if either Indrawati or Boediono — or both — are forced out, Yudhoyono will have been severely weakened, reducing prospects for reform in the remainder of his five-year term.

“This is a contest between two forces — reform and anti-reform,” said Aleksius Jemadu, a political analyst at Pelita Harapan University in Jakarta.

“If you look at what Sri Mulyani has done as minister of finance, many people appreciate it, but it’s a threat to others. There are people who will be put at risk because of her policies, for instance her tax policies. Some people feel threatened by her policies, so are trying to get rid of her through this scandal.”

Indonesia has been a star performer among emerging markets in the past year, due to strong fundamentals, a thriving domestic consumer market, but also crucially because of hopes Yudhoyono would press ahead with reforms to unlock even faster growth.

Many analysts say an upgrade of Indonesia’s sovereign debt to investment grade is within reach in a couple of years. It has been widely tipped as the country most likely to join the “BRICs” — Brazil, Russia, India and China — in the select group of essential emerging markets investors cannot afford to ignore.

Prolonged conflict over reform could put that at risk.

“In the longer term this would clearly impact people’s appetite for Indonesia,” said James Bryson, a Jakarta-based investment advisor at fund manager HB Capital.

“If that rumbles on it makes it less likely that the ratings agencies upgrade Indonesia’s sovereign rating. If progress in these areas and cleaning up the institutions isn’t made, then Moody’s, S&P will be slower to upgrade any ratings.”

POWERFUL ENEMIES

As finance minister, Indrawati has cleaned up Indonesia’s notoriously corrupt tax and customs departments in an effort to increase state revenues from tax and duties and reduce the country’s reliance on bond issues to fund the budget deficit.

To get an idea of the scale of tax evasion in Indonesia, last month, the tax department produced a list of the 100 worst tax dodgers which it said owed a total of $1.9 billion in taxes in 2009, equivalent to one-tenth of the amount that Indonesia plans to raise in the bond markets this year.

Among the various state and private sector firms on the list was a coal-mining company controlled by Aburizal Bakrie, a tycoon and politician who has clashed with Indrawati and who is seen as the driving force behind efforts to remove her.

Bakrie isn’t the only tycoon feeling the heat from the tax department. Last month, Yudhoyono asked police to help the tax department pursue dodgers and there are signs that other tax cases which had languished are being pursued more aggressively.

While the Bank Century case is unlikely to have a short-term impact on economic growth, a slower reform push would have a longer-term impact. For years, Indonesia has lagged emerging market giants China and India in terms of its growth rate.

Investors were reluctant to stump up the billions of dollars required to develop infrastructure, including ports and tollroads, or boost the natural resources and manufacturing sectors, because of Indonesia’s reputation for corruption, red tape, and legal uncertainty.

These are the main areas that Yudhoyono and his reformers have started to address. The reforms are not only intended to attract investment, but should also reduce the overall cost of borrowing by improving Indonesia’s chances of achieving an investment grade credit rating.

Yudhoyono also reversed Indonesia’s reputation as a political basket case prone to repeated bouts of instability.

While few analysts or investors expect either Indrawati or Boediono to lose their jobs over Bank Century, they recognise that attacks on the reformers are likely to continue.

“Investors are clearly worried that domestic politicians are more interested in fighting over the spoils of power, than in supporting the reform process,” said one long-term U.S.-based investor in Indonesia who declined to be quoted by name.

“With the president’s leadership, Sri Mulyani and Boediono have been vital to ensuring the benefits of Indonesia’s strong growth are more fairly shared by all Indonesians. Dismissing either reformer would lead investors to concerns that Indonesia was returning to crony capitalism, which was certainly very painful for investors and most Indonesians — at least those who weren’t tycoons or politically well-connected, or both.” (Editing by Andrew Marshall) ((sara.webb@thomsonreuters.com; Reuters messaging: sara.webb.reuters.com@reuters.net; +6221 384 6364 ext 901))

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