Last week, Indonesia’s Attorney General made a public show of questioning several witnesses in an investigation being conducted into BPJS Ketenagakerjaan, a state-operated investment fund for workers. No charges have been filed yet, but there are apparently strong suspicions that funds have been misappropriated. This follows on the heels of another major financial scandal, the failure of the state-owned insurance company PT Jiwasraya, which lost more than $1 billion through fraud and corporate malfeasance. Several people, including company executives and multi-millionaire tycoon Benny Tjokrosaputro, were sentenced to life in prison for their part in the case.
These high-profile fraud cases have important implications for the Indonesian model of economic growth which relies on large foreign capital inflows and deepening domestic capital markets, in a context in which the state typically occupies a major role in important economic sectors. Obviously, a financial system plagued by scandals in large funds owned by the state could throw a wrench into those plans.
With low or even negative interest rates in the U.S. and Europe, emerging markets like Indonesia are currently seeing large inflows of capital as investors seek higher yields. But such capital flows can cause problems down the road if they suddenly stop or reverse. There are many factors that determine how foreign investment impacts the real economy, but high-profile scandals in the financial sector are one way to accelerate the pace of outflows during a sell-off, as investors come to view the regulatory environment as unreliable and risky.
Right now, global systemic forces are pushing capital toward Indonesia. But that may not always be the case, and when yields rise again in the U.S., reputational risk will become an important factor in the extent of the pullback. This kind of reputational risk also poses considerable problems as Indonesia seeks to deepen its domestic capital markets.
An important part of Jokowi’s development strategy has been to underwrite economic growth and investment by issuing more domestic debt denominated in local currency. The country has seen a rapid increase in local rupiah bonds since Jokowi took office. Outstanding corporate bonds doubled from 222.8 trillion rupiah ($15.9 billion) in 2014 to 445.1 trillion rupiah ($31.7 billion) in 2019, while government securities have more than doubled from 1,210 trillion rupiah ($86.2 billion) to 2,752.74 trillion rupiah ($196 billion) over the same period. Although this strategy has its critics, I am not one of them – I think that by and large this debt has financed investment in infrastructure and other productive assets and is therefore a net benefit to the economy, despite the risks.
But as these markets get bigger and play a larger role in the fate of the national economy, the sustainability of this strategy hinges on the ability of regulators to ensure that the system is fair, transparent, and trustworthy. In addition to losing the life savings of people invested in these funds, continued scandals of this nature will eventually pose a systematic threat to the very model of economic growth that this administration is championing.
Indonesia’s economy operates under a state capitalist system that mixes market mechanisms with state control of key sectors through state-owned enterprises. I have previously argued that there is a logic to this kind of system, especially when it comes to sectors of national strategic importance where insulating the price of staple goods from market volatility is important, such as electricity, gas, telecommunications, and arguably even bank lending.
The case for direct state ownership of investment funds is shakier, and every time another fund owned by the state becomes insolvent due to mismanagement or fraud, it undermines the very logic of Indonesia’s state capitalist approach to development. The state-owned electric utility, PLN, is hardly a shining example of a lean profit-making machine or a paragon of good governance. But it does deliver on its fundamental mandate to provide low-cost electricity to tens of millions of customers, and therefore when it loses money this is in some ways by design.
State-owned insurance companies and investment funds on the other hand, are not only failing to deliver on their mandates, they are creating reputational risk that threatens to undo Indonesia’s state capitalist development model while undermining confidence in the capital markets that are critical to future growth. Corruption is endemic in Indonesia but if the government wants to continue on the development path it is currently on it will need to crack down on these high-profile financial scandals or the systemic risk will become increasingly acute.