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

UNCLAS SECTION 01 OF 03 JAKARTA 003296 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EAP/MTS, EAP/RSP AND EB/IFD/OMA 
TREASURY FOR IA-BAUKOL, OTA-MCDONALD 
SINGAPORE FOR TREASURY-BAKER 
COMMERCE FOR 4430-BERLINGUETTE 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN 
DEPARTMENT PASS EXIM BANK 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: INDONESIA - OBSTACLES AND PROGRESS IN CAPITAL MARKET 
DEVELOPMENT 
 
REF: A) Jakarta 978 (Insurance Sector); 
B) Jakarta 1128 (Monetary Policy Instruments); 
C) Jakarta 3099 (Foreign Restrictions on SBI) 
 
¶1. (SBU) Summary: Tax, legal and accounting issues are impeding the 
development of securities markets and products in Indonesia.  Market 
participants and some regulators argue that the lack of hedging 
instruments and financing techniques is the key obstacle to 
securities market development.  On the positive side, regulators are 
starting to research initiatives to improve the insurance industry, 
including addressing long-time insolvent firms.  Civil service 
reform is also reducing opportunities for rent seeking, which may 
improve both regulation and corporate governance.  Indonesian 
securities supervisors have requested help from the U.S. Securities 
and Exchange Commission (SEC) in improving disclosure and market 
surveillance (see para 15) and the SEC plans to respond to the 
request with a visit in early 2008. End Summary. 
 
T-Bills and SBI 
--------------- 
 
¶2. (U) Indonesia's banking sector suffers from chronic excess 
liquidity.  BI issues Sertifikat Bank Indonesia -SBIs - as part of 
open market operations.  BI uses SBI as sterilization and liquidity 
instruments with one- and three-month maturity. (See reftel B.)  Due 
to the limited supply of alternative financial assets, overseas 
investors buy SBI, which reduces the effectiveness of BI's liquidity 
management activities.  Despite Indonesia's progress in setting up a 
primary dealer's market and holding its first T-Bill auctions in 
2007, the Ministry of Finance has not yet issued T-Bills with less 
than one-year maturity. The expansion of availability of short-term 
T-Bills would not only help market development by filling in the 
short end of the yield curve, but would also provide a new monetary 
policy instrument besides SBI. 
 
¶3. (U) Currently, a 20% up-front tax hit on T-Bills appears to be a 
small - but not insurmountable -- disincentive for many investors 
and securities dealers.  However, Bank Indonesia (BI) is refusing to 
pay withholding tax on T-Bills, and therefore will not purchase them 
for use as monetary instruments.  One bond market expert noted that 
taxing a central bank on purchases of government bonds had virtually 
no precedent anywhere in the world. 
 
¶4. (SBU) The availability of T-Bills is an important aspect of the 
debate on potentially limiting foreign ownership of SBIs (reftel C). 
 Without other short-term, rupiah-denominated securities such as 
T-Bills, for foreign investors to switch into, limiting foreign 
ownership of SBIs could potentially be destabilizing to the currency 
markets.  Official sources told us, however, that there are plenty 
of ways to "work around" such a regulation, should BI ever issue it. 
 Most view such a move as unlikely and BI officials confirmed in 
meetings with the Embassy that it has no plans to restrict foreign 
ownership of SBIs or introduce capital controls in the near term. 
Nevertheless, many market participants continue to believe it would 
be in Indonesia's best interest to exclude non-resident investors 
from the SBI market.  Should foreigners ever be excluded, the GOI 
could potentially reduce any adverse impact by issuing more T-Bills 
to capture this demand. 
 
Hedging Instruments Needed, Especially Repo Market 
--------------------------------------------- ----- 
 
¶5. (SBU) Deutsche Bank's Director for Fixed Income Trading, Francis 
Soetopo, argued that the main problem in the bond market now is the 
absence of hedging instruments.  He argued that providing hedging 
instruments should be the top priority from a regulatory point of 
view. 
 
¶6. (SBU) The most important hedging tool would be a properly 
functioning repo market.  According to Citibank Country Economist 
Anton Gunawan, BI officials want to rely on the private sector to 
develop a repo market so that BI will not have to be the 
counterparty to every repo transaction, thus reducing its own risk. 
However, debt officials told us that the private sector's Master 
Repo Agreement drafted previously is not working due to accounting 
and tax problems.  Reportedly, banks that engage in repo agreements 
 
JAKARTA 00003296  002 OF 003 
 
 
are not able to effectively remove the liability from their balance 
sheet even when it is has been sold to others.  Furthermore, repo 
transactions are subject to transfer taxes, even if the assets 
revert back to their original owner at the end of the repo deal. 
 
¶7. (SBU) JP Morgan Managing Director Rizal Prasetijo also argued 
that international financial institutions are required to limit 
counter-party risk associated with local Indonesian banks.  This 
means that the lines of credit available in local bank-to-bank repo 
agreements would be very small.  He argued, therefore, that Bank 
Indonesia will have to be the counterparty for the foreseeable 
future if they want to have a deep and liquid repo market.  However, 
even if BI were to seek a direct role as counterparty in repo 
transactions, they are unlikely to warehouse the variety of 
inventory required or want to disburse and/or absorb large cash 
balances at the request of the dealer community. 
 
Hope for Progress after Stock Exchange Merger 
--------------------------------------------- 
 
¶8. (SBU) BAPEPAM Chairman Fuad Rahmany believes that the merger of 
the Jakarta (JSX) and Surabaya Stock Exchanges (SSX) will set the 
stage for development of better derivatives markets, although there 
will be some rough patches during the transition period.  The merged 
exchanges, legally effective on November 30, are now called the 
Indonesia Stock Exchange (Bursa Efek Indonesia or BEI).  Previously 
the SSX, which specialized in bond trading, wanted to explore 
derivatives (futures, options, real-estate investment trusts) but 
the underlying asset was often traded on the larger, more liquid 
JSX.  Trading related securities on different exchanges creates 
problems in coordinating market surveillance to guard against market 
manipulation.  As soon as the merged entity is stable, one bond 
market official predicted that the MOF and BAPPEPAM would roll out 
bond futures early next year.  The SSX was already in the advanced 
stages of developing a financial futures contract for government 
bonds. 
 
Addressing Taxation of Securities 
--------------------------------- 
 
¶9. (SBU) Rahmany also mentioned that tax was the biggest hurdle in 
terms of securitization products, such as asset-backed securities. 
In addition to tax, real estate investment trusts (REITs) and 
mortgage backed securities are also held up by the national land 
agency, BPN.  Two new government regulations are needed to address 
land title issues, custodial titles, the structure of new products 
and their tax treatment. 
 
¶10. (U) The government does seem to have recognized the myriad of 
tax problems holding back market development.  In response, Dr. 
Anggito Abimanyu, Head of the Ministry of Finance Fiscal Policy 
Office said that the Ministry of Finance is drafting a new law in 
2008 to address tax treatment of: 
 
-- Financial securities (which he noted were not covered under 
income tax); 
 
-- Sharia bonds and other sharia investment instruments; 
 
-- Derivatives and asset-backed securities. 
 
Diversifying and Shoring Up Domestic Bond purchasers 
--------------------------------------------- ------- 
 
¶11. (SBU) Rahmany said plans also were being developed to encourage 
more domestic players to participate in bond markets.  One market 
expert reported that most insurance and pension assets are invested 
in shorter-term bank deposits rather than longer-term assets such as 
government or corporate bonds.  This is partly due to regulatory 
rules that count 12-month deposits, but not government bonds, as 
regulatory reserves. 
 
¶12. (SBU) Most observers believe that the resulting asset-liability 
mismatch has been allowed to persist due to concern about the 
solvency of a few large firms and pension funds.  Rahmany admitted 
that the insurance regulator had been weak, and the Ministry of 
 
JAKARTA 00003296  003 OF 003 
 
 
Finance is now trying to compensate for past neglect.  At the 
industry level, former Coordinating Minister for the Economy 
(2001-2004) and Indonesian Ambassador to the U.S. (1998-2001) 
Dorodjatun Kuntjoro Jakti agreed to chair a "Blue Ribbon Commission" 
on insurance reform, long requested by international insurers in 
Indonesia to examine ways to improve the laggard sector.  Terms of 
reference for the Commission are being drafted and will be submitted 
to BAPEPAM-LK for comment in the coming weeks. 
 
GOI Confirms It Will Bail Out Large Insurer 
------------------------------------------- 
 
¶13. (SBU) More narrowly, Rahmany confided that the GOI was looking 
for ways to bail out bankrupt insurer Bumiputera 1912 (reftel A), 
which has around 6 million policy holders.  Due to the size and 
sensitivity of the bailout, Rahmany asked for our discretion, noting 
that it will be a very sensitive issue, requiring a presentation to 
Parliament, with a request to spend public money on the bailout. 
Despite its government connections - historically many rural civil 
servants supplemented their wages by selling its policies for 
commissions -- Bumiputera is technically a mutually-owned life 
company, not a state-owned company.  "Eventually, we will have to 
demutualize it," Rahmany said. As Bumiputera 1912 is also the only 
mutual life insurance company in Indonesia, that path will be 
challenging. 
 
Some Progress on Reducing Rent Seeking 
-------------------------------------- 
 
¶14. (U) Civil service reform is helping to reduce some incentives 
and opportunities for rent seeking by regulators and other 
government officials.  First, under the leadership of Finance 
Minister Mulyani and BAPEPAM Chairman Fuad Rahmany, salaries have 
tripled for BAPEPAM employees and raised significantly for high 
level Ministry of Finance officials (particularly those in Echelon 
1). Secondly, Ministry of Finance Head of Fiscal Policy Anggito 
Abimanyu - who also sits on the board of PT Telkom, Indonesia's 
state-owned telecom company -- reported that a new policy requires 
government employees to refuse salaries provided as members of 
boards of directors or commissioners.  The new policy applies to the 
Ministry of Finance, the Supreme Audit Board (BPK), and the Supreme 
Court this year and is planned for the armed forces, police and 
judges next year.  According to the plan, all central government 
officials will have to refuse any additional corporate salaries by 
¶2012. 
 
SEC Assistance Sought 
--------------------- 
 
¶15. (U) Rahmany said that BAPEPAM is grateful for assistance from 
the U.S. Treasury, the U.S. Securities and Exchange Commission, as 
well as Australia's Securities and Investment Commission (ASIC). 
Rahmany requested that the SEC team he requested for a review of 
market enforcement tools, come as early as possible in 2008. 
Rahmany would also like to see a review of the disclosure rules for 
listed companies.  "There is a lot of misbehavior in our markets," 
Rahmany acknowledged.  He seeks SEC assistance with two major items: 
the enforcement process including the Attorney General's Office 
(AGO) and techniques and analysis to review suspected cases of 
market manipulation.  State, Treasury, IMF, SEC, and the Australia's 
Technical Assistance Management Facility for Economic Governance 
(TAMF) have been coordinating on assistance to BAPEPAM. 
 
HUME