Indonesia targets finance access for small businesses

Even though Indonesia’s government has implemented a range of measures that seek to foster growth in the manufacturing sector – including enhanced investment incentives and the development of industrial zones – small businesses remain challenged by several fundamental structural issues that hinder their ability to access credit.

The nation has welcomed the entrance of international manufacturers over the years, but the segment is still dominated by micro- and small enterprises, with Statistics Indonesia (BPS) estimating that more than 3.6m manufacturing units in Indonesia fall under the micro and small categories. Because of limited access to financial services, these smaller enterprises have struggled to adapt to Indonesia’s evolving business climate and are often unable to capitalise on growth opportunities. According to recent statistics from the UN Industrial Development Organisation, Indonesia’s manufacturing segment contributes 1.9% to value added worldwide. The market consensus is that an expansion of funding options would promote the development of downstream activity.

Considering the growth prospects, industry insiders are calling for the development of a new special funding institution and the establishment of a special microcredit scheme to aid development, though the establishment of such an institution or scheme has yet to be officially announced under government plans. However, efforts to remove barriers to credit are among the cornerstones of President Joko Widodo’s development agenda, and reforms to promote access to financial services for small and micro-enterprises are gaining traction.

BARRIERS TO CREDIT: For the most part, access to credit for small enterprises is fairly narrow, particularly in rural areas. Historically, micro-organisations have struggled to meet collateral requirements, while even small to medium-sized businesses have faced high interest rates. According to a Bank of Indonesia study in 2010, micro-, small and medium-sized enterprises (MSMEs) were confronted with a host of barriers in accessing credit, many of which are still present today, albeit to a lesser extent. In many cases, family businesses within the micro category do not have an official legal status, business licence or even a tax registry number, which has historically made access to finance through a formal channel problematic. Some progress has been made in this area; commercial loans to micro-businesses no longer require complete documentation, though small businesses require a licence to access loans and those for medium-sized businesses demand multiple licences. Legal status at the small to medium-sized level has improved a great deal, but geographic location does hinder access to financial services for many businesses, as there are varying degrees of supply at the provincial level.

Due to the limited risk appetite from most banks, 81.4% of small enterprises rely on their own capital to fund the business, according to a 2015 BPS survey. Furthermore, of the family businesses that did manage to borrow funds, only 38% were able to do so through an official banking channel. Collateral, high interest rates and legal requirements were cited as the main reasons for MSME reluctance to seek loans from banks. “Multi-financing companies can play a role in addressing this financing gap encountered by MSMEs,” Yannuar Alin, president director of Buana Finance, told OBG.

OPENING ACCESS: In an effort to facilitate financing for MSMEs, the government established a micro-credit programme, known locally as Kredit Usaha Rakyat (KUR). Initially launched in 2007, KUR loans require no collateral and the government provides a partial guarantee, which assists with banking risk appetite. However, within the KUR programme the rate of non-performing loans is high, sitting at 21-31% in 2015, which far exceeded the 5% thresholdset for regular loans. Due to high non-payment risk, banks set very high interest rates for this microfi-nance programme. Government intervention came in 2015, cutting the interest rate from 22% to 12%, and as of the first quarter of 2017 the KUR interest rate stood at 9%. Despite having lower interest rates, KUR financing within the manufacturing segment is scarce, with only 3% of sector enterprises accessing a loan through the initiative.

Even if demand for KUR loans increases within the manufacturing segment, the long-term viability of the programme is questionable, with some industry players saying that the subsidised interest rates are financially unstable. In April 2017 the World Bank told local media that the 9% rate “only allows banks to meet a small share of their costs in the microfinance segment, both currently and for the coming year. Thus, the offerings at that rate will not be commercially viable in the medium term, and the government would have to pay subsidies on a recurring basis, if it seeks to maintain the rate”.

FROM THEN TO NOW: The so-called special micro-credit scheme that industry insiders are eager to see implemented would in other markets fall under the remit of an industrial development bank. Until the end of the 20th century, Bank Pembangunan Indonesia (BAPINDO) fulfilled that role. BAPINDO, working alongside a number of development agencies, played a significant role in the progression of strategic sectors and provided much-needed funding to small enterprises. After a successful run of projects commencing in 1960, the bank was merged with three others to form Bank Mandiri in 1999. The state-owned bank is now the country’s largest by assets (see Banking chapter).

To address the absence of a financial institution specifically geared towards industry financing, Airlangga Hartarto, the minister of industry, publicly announced in February 2017 that the diversion of funds from state-owned enterprises – like Sarana Multi Infrastruktur and the Indonesian Export Financing Agency – could be used to fill the financing gap within the industrial segment. Hartarto told local media, “We would like to encourage export-oriented, labour-intensive industries with tax incentives, in addition to the funding.”

Before BAPINDO ceased its operations and prior to the 1997-98 Asian financial crisis, expansion within the manufacturing sector outperformed GDP averages. However, over the last decade the sector has grown at a rate of single-digit figures, expanding by 4.3% in 2016. Onlookers and industry insiders continue to point to barriers to credit as one of the main reasons for this slowing of growth, in addition to commodity price downturns and slackening global economic activity.

IMPACT: Indonesia has a long history of supporting MSMEs, and the process of directing greater financing to the industrial segment is already in the works. Additionally, the government has initiated a review of its KUR credit guarantee programme, and the introduction of a new special microcredit scheme is on the table. From which pocket of the economy the future funding comes from remains to be seen, but the government appears to be set on creating a more conducive financial environment that encourages a sustainable lending system.

All things considered, the implementation of a robust and inclusive financial system will ease the burden small enterprises feel, as it will reduce the need to rely upon personal savings and earnings to build a company. At the same time, it will enable entrepreneurs to better mitigate future market risks, while also giving them greater leverage to capture promising growth opportunities.

In a broader sense, the adoption of sound financial policies geared towards better access to credit for small and micro-enterprises will act as an important catalyst for the development of downstream activity, thereby supporting the evolution of Indonesia’s manufacturing segment, as there is an abundance of evidence that shows that access to finance is vital for the development of local industry. Likewise, there is growing recognition among policymakers that increasing access to financial services encourages economic growth and assists with poverty alleviation. These factors are driving the Widodo administration to close the financial gaps that have historically weighed heavily on entrepreneurs.

Moving forward, however, there will still be a number of major challenges, such as identifying organisations that have genuine growth potential at the banking level. There may also be difficulties navigating lowered interest rates that are aimed at a single segment, as this may create complications. Access to such financing could be used to satisfy personal wages or family expenses at the micro level, which would reduce reinvestment in the business as well as increase the risk of a non-performing loan.